Running Head: CORPORATE FINANCE
“Carpet Baggers Inc. is proposing to construct a new bagging plant in a country in Europe. The two prime candidates are Germany and Switzerland. The forecasted cash flows from the proposed plants are as follows:”
“The spot exchange rate for euros is $1.3/€, while the rate for Swiss francs is CHF 1.5/$. The interest rate is 5% in the United States, 4% in Switzerland, and 6% in the euro countries. The financial manager has suggested that, if the cash flows were stated in dollars, a return more than 10% would be acceptable. Should the company go ahead with either project? If it must choose between them, which should it take?”
To evaluate various financial decisions of companies there are various tools used. The most common is net present value. For Carpet Baggers Inc. to know which project to take, we use net present value to assess the profitability of each project. Net present value is the difference that occur between the present value of cash inflows and the present value of cash outflows over a period which may be a month, a year or even five years. when calculating the net present value, we analyze the profitability of a project over that future period (2021). We use the simple principle of profit and loss where we subtract cash outflows from cash inflows to know whether the project is profitable or not.
In this scenario we will use the principle of calculating net present value in other currencies and countries since the investment is between two different countries. It should be noted that the principles of capital investment are the same across the world. Net present values considers the time value of money and is used in comparison of two similar investments. The project that has a negative net present value is avoided and the one with a positive net present values is preferred (2021).
The first step is to determine Carpet Baggers Inc. discount rate using the expected return. We should then identify the number of periods or time. We should then calculate the present values of future cashflows. The following is the calculation of Germany’s cashflows net present value using the minimum required rate of return.
As shown in the calculation above, the Net present value in dollars is 10.11 million. That is the Net present value of Germany’s cash flows.
The next step will be the calculation of Switzerland cash flows using the let required rate of return. The following are the calculations.
In the case of Switzerland, the Net present value in dollars is 10.25 million.
It is seen both plans of Carpet Baggers Inc. have positive Net Present values. That shows both plans are accepted and can be taken. But, if Carpet Baggers Inc. should choose just one among the two, Switzerland should be preferred because its Net present value is relatively higher than that of Germany.
Unife.it. (2021). Retrieved 21 June 2021, from http://www.unife.it/economia/lm.economia/insegnamenti/financial-management/teaching-material-a-a-2019-20/Readings-and-articles/4-brealey-myers-and-allen-principles-of-corporate-finance-ch-5-6#:~:text=The%20difference%20between%20a%20project’s,net%20present%20value%20(NPV).&text=Instead%20of%20calculating%20a%20project’s,investments%20in%20the%20capital%20market.
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