Test Bank Chapter 18 International Capital Budgeting

Student name:__________

1) Capital budgeting analysis is very important, because it

A) involves, usually expensive, investments in capital assets.
B) has to do with the productive capacity of a firm.
C) will determine how competitive and profitable a firm will be.
D) all of the options

2) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

What is the unlevered after-tax incremental cash flow for year 0?

A) −$3,660,000
B) −$5,100,000
C) −$4,000,000
D) −$4,010,000

3) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

What is the unlevered after-tax incremental cash flow for year 2?

A) −$4,610
B) $102,300
C) $202,300
D) $255,000

4) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

What is the unlevered after-tax incremental cash flow for year 30?

A) $12,432,300
B) $12,225,390
C) $12,332,300
D) $12,485,000

5) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments.

What is the levered after-tax incremental cash flow for year 0?

A) −$1,010,000
B) −$1,000,000
C) −$660,000
D) −$2,100,000

6) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments.

What is the levered after-tax incremental cash flow for year 1?

A) $4,300
B) −$202,610
C) −$95,700
D) $57,000

7) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments.

What is the levered after-tax incremental cash flow for year 30?

A) $9,027,390
B) $9,234,300
C) $9,134,300
D) $9,287,000

8) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

Assume that the firm will partially finance the project with a subsidized $3,000,000 interest only 30-year loan at 8.0 percent APR with annual payments. Note that eight percent is less than the 10 percent that they normally borrow at.

What is the NPV of the loan?

A) $198,469
B) $53,979.83
C) $102,727.55
D) $1,334,851.09

9) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-equity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent.

What is the firm's cost of equity capital?

A) 33.33 percent
B) 10.85 percent
C) 13.12 percent
D) 16.5 percent

10) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital.

The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-equity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent.

What is the required return on assets?

A) 33.33 percent
B) 10.85 percent
C) 13.12 percent
D) 16.5 percent

11) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing) payments over 3 years. The first payment is due today and your taxes are due January 1 of each year on the previous year's income. The yield to maturity on your firm's existing debt is 8 percent. What is the APV of this subsidized loan? If you rounded in your intermediate steps, the answer may be slightly different from what you got. Choose the closest.

A) −$3,497,224.43
B) $417,201.05
C) $840,797
D) none of the options

12) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing) payments over 3 years. The first payment is due December 31, 2009 and your taxes are due January 1 of each year on the previous year's income. The yield to maturity on your firm's existing debt is 8 percent. What is the APV of this subsidized loan? Note that I did not round my intermediate steps. If you did, your answer may be off by a bit. Select the answer closest to yours.

A) −$3,497,224.43
B) $417,201.05
C) $840,797
D) none of the options

13) The required return on assets is 18 percent. The firm can borrow at 12.5 percent; firm's target debt to value ratio is 3/5. The corporate tax rate is 34 percent, and the risk-free rate is 4 percent and the market risk premium is 9.2 percent.

What is the weighted average cost of capital? The firm has a beta of 2.11.

A) 12.15 percent
B) 13.02 percent
C) 14.33 percent
D) 23.45 percent

14) Your firm is in the 34 percent tax bracket. The yield to maturity on your existing bonds is 8 percent. The state of Georgia offers to loan your firm $1,000,000 with a two year amortizing loan at a 5 percent rate of interest and annual payments due at the end of the year.
The interest will be deductible at the time that you pay. What is the APV of this below-market loan to your firm? I did not round any of my intermediate steps. You might be a little bit off. Pick the answer closest to yours.

A) $64,157.38
B) $417,201.05
C) $840,797
D) none of the options

15) The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-equity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent. Calculate the weighted average cost of capital.

A) 33.33 percent
B) 8.09 percent
C) 9.02 percent
D) 16.5 percent

16) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent.

Using the weighted average cost of capital methodology, what is the NPV? I didn't round my intermediate steps. If you do, you're not going to get the right answer.

A) −$1,406,301.25
B) $12,494,643.75
C) $36,580,767.55
D) $108,994.618.20

17) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent.

What is the levered after-tax incremental cash flow for year 2?

A) $185,796,000
B) $215,152,000
C) $267,952,000
D) $284,848,000

18) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent.

What is the levered after-tax incremental cash flow for year 4?

A) $281,704,000
B) $465,152,000
C) −$194,848,000
D) $460,796,000

19) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent.

Using the flow to equity methodology, what is the value of the equity claim?

A) −$1,540,000
B) $446,570,866.00
C) $36,580,767.55
D) $470,953,393.70

20) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent.

Using the APV method, what is the value of this project to an all-equity firm?

A) −$46,502,288.10
B) $12,494,643.75
C) $36,580,767.55
D) −$67,163,445.12

21) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent.

Using the APV method, what is the value of the debt side effects?

A) $239,072,652.70
B) $66,891,713.66
C) $59,459,301.03
D) $660,000,000

22) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent.

Using the weighted average cost of capital methodology, what is the NPV? I didn't round my intermediate steps. If you do, you're not going to get the right answer.

A) −$1,406,301.25
B) $12,494,643.75
C) $36,580,767.55
D) $108,994.618.20

23) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent.

What is the levered after-tax incremental cash flow for year 2?

A) $185,796,000
B) $215,152,000
C) $267,952,000
D) $284,848,000

24) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent.

What is the levered after-tax incremental cash flow for year 4?

A) −$281,704,000
B) $465,152,000
C) −$194,848,000
D) $460,796,000

25) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent.

Using the flow to equity methodology, what is the value of the equity claim?

A) −$1,540,000
B) $446,570,866.00
C) $36,580,767.55
D) $30,716,236.13

26) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent.

Using the APV method, what is the value of this project to an all-equity firm?

A) −$46,502,288.10
B) $12,494,643.75
C) $36,580,767.55
D) −$67,163,445.12

27) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:
{MISSING IMAGE}
The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent.

Using the APV method, what is the value of the debt side effects?

A) $239,072,652.70
B) $66,891,713.66
C) $59,459,301.03
D) $660,000,000

28) Your firm's existing bonds trade with a yield to maturity of eight percent. The state of Missouri has offered to loan your firm $10,000,000 at zero percent for five years. Repayment will be of the form of $2,000,000 per year for five years; the first payment is due in one year.

What is the value of this offer?

A) $4,729,622.75
B) $2,014,579.93
C) $0
D) $196,929.88

29) What proportion of the firm is financed by debt for a firm that expects a 15 percent return on equity, a 12 percent return on assets, and a 10 percent return on debt?

The tax rate is 25 percent.

A) 20 percent
B) 1/3
C) 60 percent
D) 2/3

30) The required return on equity for an all-equity firm is 10.0 percent. They are considering a change in capital structure to a debt-to-equity ratio of ½ the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the new cost of capital if this firm changes capital structure.

A) 14.93 percent
B) 8.67 percent
C) 7.40 percent
D) none of the options

31) The required return on equity for an all-equity firm is 10.0 percent. They currently have a beta of one and the risk-free rate is 5 percent and the market risk premium is 5 percent. They are considering a change in capital structure to a debt-to-equity ratio of ½ the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the beta if this firm changes capital structure.

A) 1.12
B) 1
C) 7.4 percent
D) none of the options

32) What is the expected return on equity for firm in the 40 percent tax bracket with a 15 percent expected return on assets that pays 12 percent on its debt, which totals 25 percent of assets?

A) 24 percent
B) 15.60 percent
C) 16 percent
D) 20 percent

33) Assume that XYZ Corporation is a leveraged company with the following information:

K_l = cost of equity capital for XYZ = 13%
i = before-tax borrowing cost = 8%
t = marginal corporate income tax rate = 30%

Calculate the debt-to-total-market-value ratio that would result in XYZ having a weighted average cost of capital of 9.3 percent.

A) 35 percent
B) 40 percent
C) 45 percent
D) 50 percent

34) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing) payments over 3 years. The first payment is due today and your taxes are due January 1 of each year on the previous year's income. The yield to maturity on your firm's existing debt is 8 percent. What is the NPV of this subsidized loan?
Note that I did not round my intermediate steps. If you did, your answer may be off by a bit. Select the answer closest to yours.

A) $406,023.10
B) $840,797
C) $64,157.38
D) $20,659.77

35) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing) payments over 3 years. The first payment is due today and your taxes are due January 1 of each year on the previous year's income. The yield to maturity on your firm's existing debt is 8 percent.
What is the €-denominated NPV of this project? I did not round my intermediate steps, if you did, select the answer closest to yours.

A) €5,563.23
B) €2,270.79
C) €7,223.14
D) €3,554.29

36) The spot exchange rate is ¥125 = $1. The U.S. discount rate is 10 percent; inflation over the next three years is 3 percent per year in the U.S. and 2 percent per year in Japan. Calculate the dollar NPV of this project.
{MISSING IMAGE}
I did not round my intermediate steps, if you did, select the answer closest to yours.

A) $267,181.87
B) $14,176.67
C) $2,536.49
D) $2,137.46

37) In the context of the capital budgeting analysis of an MNC that has strong foreign competitors, "lost sales" refers to

A) the cannibalization of existing projects by new projects.
B) the entire sales revenue of a new foreign manufacturing facility representing the incremental sales revenue of the new project.
C) Both A & B are correct.
D) none of the options

38) Which of the following statements is false about "borrowing capacity"?

A) It is an especially important point in international capital budgeting analysis because of the frequency of large concessionary loans.
B) It creates tax shields for APV analysis regardless of how the project is actually financed.
C) It is synonymous to the "project debt."
D) It is based on the firm's optimal capital structure.

39) The adjusted present value (APV) model that is suitable for an MNC is the basic net present value (NPV) model expanded to

A) distinguish between the market value of a levered firm and the market value of an unlevered firm.
B) discern the blocking of certain cash flows by the host country from being legally remitted to the parent.
C) consider foreign currency fluctuations or extra taxes imposed by the host country on foreign exchange remittances.
D) all of the options

40) Given the following information for a levered and unlevered firm, calculate the difference in the cash flow available to investors. Assume the corporate tax rate is 40 percent.
(Hint: Calculate the tax savings arising from the tax deductibility of interest payments).

A) $8
B) $18
C) $78
D) $90

41) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the one-year forward rate that should prevail?

A) €1.00 = $1.2379
B) €1.00 = $1.2139
C) €1.00 = $0.9903
D) $1.00 = €1.2623

42) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next three years in the U.S. is 2 percent and 3 percent in the euro zone. What spot exchange rate should prevail three years from now?

A) €1.00 = $1.2379
B) €1.00 = $1.2139
C) €1.00 = $0.9903
D) $1.00 = €1.2623

43) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.


The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent.

What is CF0 in dollars?

44) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.


The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent.

What is CF1 in dollars?

45) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.


The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent.

What is CF5 in dollars?

46) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.


The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent.

What is the NPV of the U.S.-based project to the Irish firm?

47) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.


The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent.

What is the dollar-denominated IRR?

48) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.


The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent.

What is the euro-denominated IRR?

49) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.


The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent.

Find the break-even price (in dollars) and break-even quantity for the U.S. project.

50) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.


The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget.
The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.
The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S.
For simplicity, assume that taxes are paid like sales taxes: immediately.
The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent.

Repeat the above project analysis assuming that the Irish firm could replicate the project in Ireland. (i.e. cash flow out the project in Ireland and find break-even price (in €), quantity, NPV, IRR (in euro not dollars).

51) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up.

{MISSING IMAGE}

The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent.

Find the euro-zone cost of capital to compute is the dollar-denominated NPV of this project.

52) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up.

{MISSING IMAGE}

The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent.

Find the dollar cash flows to compute the dollar-denominated NPV of this project.

53) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up.

{MISSING IMAGE}

The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent.

What is the dollar-denominated IRR of this project?

54) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up.

{MISSING IMAGE}

The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent.

What is the euro-denominated IRR of this project?

55) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up.

{MISSING IMAGE}

The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent.

Find the euro-zone cost of capital to compute is the dollar-denominated NPV of this project.

56) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up.

{MISSING IMAGE}

The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent.

Find the dollar cash flows to compute the dollar-denominated NPV of this project.

57) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up.

{MISSING IMAGE}

The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent.

What is the dollar-denominated IRR of this project?

58) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up.

{MISSING IMAGE}

The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent.

What is the euro-denominated IRR of this project?

59) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Find the ex post IRR in euro for the French firm if they undertake the project today and then the exchange rate falls to S₁(€|£) = €1.80 per £.

60) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Find the ex post IRR in euro for the French firm if they undertake the project today and then the exchange rate rises to S₁(€|£) = €2.20 per £.

61) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Find the IRR in euro for the French firm if they wait one year to undertake the project after the exchange rate rises to S₁(€|£) = €2.20 per £.

62) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Find the NPV in euro for the French firm if they wait one year to undertake the project after the exchange rate rises to S₁(€|£) = €2.20 per £.

63) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Find the IRR in euro for the French firm if they wait one year to undertake the project after the exchange rate falls to S₁(€|£) = €1.80 per £.

64) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Find the NPV in euro for the French firm if they wait one year to undertake the project after the exchange rate falls to S₁(€|£) = €1.80 per £.

65) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

The CFO who has a CFA notices the optionality in starting this project today. He asks you to comment and outline your valuation strategy.

66) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Your banker quotes the euro-zone risk-free rate at i_€ = 6% and the British risk free rate at i_£ = 6%. Find the value of the option and thereby the project.

67) A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%. The firm's local cost of capital is i_€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00.

Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S₁ (€|£) = €2.20 per £

S₁ (€|£) = €1.80 per £

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Using the notion of a hedge ratio, make a recommendation vis-à-vis how to undertake the project today without "buying" the option.

68) An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i_€ = 5%. The bond costs €1,000 today and will return €1,050 at the end of one year without risk. The current exchange rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:


S₁ ($|€) = €1.80 per €

S₁ ($|€) = €1.40 per €

Following revaluation, the exchange rate is expected to remain steady for at least another year.

The hedge fund manager notices the optionality in starting this project today. He asks you to comment and outline your valuation strategy.

69) An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i_€ = 5%. The bond costs €1,000 today and will return €1,050 at the end of one year without risk. The current exchange rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:


S₁ ($|€) = €1.80 per €

S₁ ($|€) = €1.40 per €

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Your banker quotes the euro-zone risk-free rate at i€ = 5% and the U.S. risk free rate at i_$ = 4%. Find the value of the option and thereby the correct value of the bond to a U.S. investor.

70) An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i_€ = 5%. The bond costs €1,000 today and will return €1,050 at the end of one year without risk. The current exchange rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:


S₁ ($|€) = €1.80 per €

S₁ ($|€) = €1.40 per €

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Using your results to the last question, make a recommendation vis-à-vis when to buy the bond.

71) An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i_€ = 5%. The bond costs €1,000 today and will return €1,050 at the end of one year without risk. The current exchange rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:


S₁ ($|€) = €1.80 per €

S₁ ($|€) = €1.40 per €

Following revaluation, the exchange rate is expected to remain steady for at least another year.

Using the notion of hedging, make a recommendation vis-à-vis how to undertake the project today without "buying" the option.

72) The Strik-it-Rich Gold Mining Company is contemplating expanding its operations. To do so it will need to purchase land that its geologists believe is rich in gold. Strik-it-Rich's management believes that the expansion will allow it to mine and sell an additional 2,000 troy ounces of gold per year. The expansion, including the cost of the land, will cost $500,000. The current price of gold bullion is $425 per ounce and one-year gold futures are trading at $450.50 = $425 × (1.06). Extraction costs are $375 per ounce. The firm's cost of capital is 10 percent.

Strik-it-Rich's management is, however, concerned with the possibility that large sales of gold reserves by Russia and the United Kingdom will drive the price of gold down to $390 for the foreseeable future. On the other hand, management believes there is some possibility that the world will soon return to a gold reserve international monetary system. In the latter event, the price of gold would increase to at least $460 per ounce. The course of the future price of gold bullion should become clear within a year. Strik-it-Rich can postpone the expansion for a year by buying a purchase option on the land for $25,000.

Compute the NPV at the current price of gold. Hint: think of the gold mine as a perpetuity.

73) The Strik-it-Rich Gold Mining Company is contemplating expanding its operations. To do so it will need to purchase land that its geologists believe is rich in gold. Strik-it-Rich's management believes that the expansion will allow it to mine and sell an additional 2,000 troy ounces of gold per year. The expansion, including the cost of the land, will cost $500,000. The current price of gold bullion is $425 per ounce and one-year gold futures are trading at $450.50 = $425 × (1.06). Extraction costs are $375 per ounce. The firm's cost of capital is 10 percent.

Strik-it-Rich's management is, however, concerned with the possibility that large sales of gold reserves by Russia and the United Kingdom will drive the price of gold down to $390 for the foreseeable future. On the other hand, management believes there is some possibility that the world will soon return to a gold reserve international monetary system. In the latter event, the price of gold would increase to at least $460 per ounce. The course of the future price of gold bullion should become clear within a year. Strik-it-Rich can postpone the expansion for a year by buying a purchase option on the land for $25,000.

Compute the NPV at the two possible prices of gold.