Question

Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate the project after four years. Baps' cost of capital is 13%, and the project is of the same risk as Baps' existing projects. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK): Year 1 Year 2 Year 3 Year 4 NOK10,000,000 NOK15,000,000 NOK17,000,000 NOK20,000,000 The current exchange rate of the Norwegian kroner is $.135. Baps' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below: Year 1 Year 2 Year 3 Year 4 $.13 $.14 $.12 $.15 Refer to Exhibit 14-1. Assume that NOK8,000,000 of the cash flow in year 4 represents the salvage value. Baps is not completely certain that the salvage value will be this amount and wishes to determine the break-even salvage value, which is $____. a. 510,088.04 b. 1,710,088 c. 1,040,000 d. none of the above

Answer 1

Answer:

d. none of the above

Explanation:

F0 -$ 5,000,000

F1  10,000,000 NOK at $ 0.13 =  1,300,000

F2 15,000,000 NOK at $ 0.14 =  2,100,000

F3  17,000,000 NOK  at $0.12 = 2,040,000

F4 12,000,000 NOK at $0.15 =   1,800,000

We now discount each cash flow according to the present value

$\left[\begin{array}{ccc}Year&cashflow&PV\\&&-5,000,000\\1&1,300,000&1,150,442.4779\\2&2,100,000&1,644,608.0351\\3&2,040,000&1,413,822.331\\4&1,800,000&1,103,973.7098\\&TOTAL&312,846.5538\\\end{array}\right]$

The project already is profitable without the salvage value therefore there is no salvage valeu that makes indifirrent whether or not to do the project.

We are missing 791,127.156 today we solve for the future value of this to get the break even salvage value: