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FINA3020 Assignment4 2324

The document provides details and questions for an assignment on international finance. It includes questions about foreign direct investment, net present value calculations, and a capital budgeting case study analyzing a proposed sugar refinery project.

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168 views2 pages

FINA3020 Assignment4 2324

The document provides details and questions for an assignment on international finance. It includes questions about foreign direct investment, net present value calculations, and a capital budgeting case study analyzing a proposed sugar refinery project.

Uploaded by

younes.louafiiiz
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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FINA3020 International Finance

Assignment 4

Due Date: 8 April 2024 (9:30am for FINA3020C or 2:30pm for FINA3020B)

Questions:

1. Briefly explain why China emerged as one of the most important recipients of FDI in recent
years. [2 marks]

2. Suppose that UK Motors Ltd. is considering an investment of £30 million to develop a new
factory. Assume that the company’s stockholders require a 22% rate of return, that the
company’s bondholders require a 9% rate of return, that the UK corporate tax rate is 40%,
that 35% of the project will be financed by debt, and that 65% of the project will be financed
with equity. What must be the annual income from the project if it is to be a zero net present
value investment? [2 marks]

3. Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in


South Africa. The initial cost of the project is ZAR10,000. The annual cash flows over
the five year economic life of the project in ZAR are estimated to be 3,000, 4,000, 5,000,
6000, and 7,000. The parent firm’s cost of capital in dollars is 9.5 percent. Long-run
inflation is forecasted to be 3 percent per annum in the U.S. and 7 percent in South Africa.
The current spot foreign exchange rate is ZAR/USD = 3.75.

a. Determine the NPV of the project in USD by converting the USD cost of capital to the
equivalent ZAR cost of capital using the Interest Rate Parity. [2 marks]

b. Determine the NPV of the project in USD by converting the ZAR cash flows to the
equivalent USD cash flows using Relative PPP to forecast exchange rates. [2 marks]

c. Are the two USD NPVs different or the same? Explain your answer. [2 marks]

The following information relates to questions 4 to 10:

Sugar Baby Corp. (SBC) is considering whether to build a refinery in the U.S. state of Georgia
to serve its North American market. SBC is based in the UK and processes raw sugar into
premium gourmet sugar. Currently, SBC exports 100,000kg of sugar per year to its North
American customers and realizes a contribution margin of GBP 3 per kg sold. SBC is certain
that the new refinery in the U.S. would meet all the current demand in North America and sales
volume would likely increase. SBC does not foresee it will be able to sell any of the amount
currently exported to North America once the new refinery is operational.

SBC estimates that it could sell 390,000kg of sugar in North America during the first year of
operations, and sales volume would grow at 5% annually. SBC plans to price its product at
USD 7.70 per kg. Total operating costs are expected to be USD 3.30 per kg. Both the sales
price and operating costs are expected to keep pace with the U.S. inflation rate forecast of 3%
per annum for the next 3 years. The UK inflation rate is estimated at 4.5% per annum for the
next 3 years. The current USD/GBP spot rate is 1.50. SBC believes that Relative PPP is the
best predictor of future exchange rates.

1
The expected initial cost of the refinery is USD 4.5 million. SBC plans to finance this amount
by a combination of debt and equity capital. The refinery will increase SBC’s borrowing
capacity by GBP 2 million, and it plans to borrow only that amount. The State of Georgia will
provide a concessionary loan of USD 1.5 million for a period of 3 years at an interest rate of
7.75%. Principal on the loan will be repaid in equal installments over the life of the loan. At
this point, SBC is uncertain whether to raise the remaining debt it requires through a domestic
bond issue at 10.75% or a Eurodollar bond issue at 9.5%. SBC’s all-equity cost of capital is
15%.

The U.S. Internal Revenue Service will allow SBC to depreciate the new refinery over a 3-year
period on a straight-line basis. After that, the refinery equipment is expected to have substantial
market value. The UK and the U.S. have the same corporate tax rate of 35%. There are no
restricted funds available for SBC to offset the cost of the initial investment. SBC prefers to
use Lessard’s APV model for capital budgeting analysis.

4. Compute the present value of after-tax incremental operating cash flows (OCF) in GBP. [6
marks]

5. Compute the present value of the depreciation tax shields. Why are depreciation tax shields
discounted at the domestic cost of debt? [4 marks]

6. Compute the present value of the benefit from the concessionary loan in GBP. [8 marks]

7. Using the Fisher Effect, explain whether SBC should borrow the remaining GBP 1 million
through a domestic (i.e., UK) bond issue or a Eurodollar bond issue. [4 marks]

8. With the bond you selected in question (7), compute the present value of the interest tax
shields in GBP. [3 marks]

9. Compute the present value of the interest tax shields from the concessionary loan in GBP.
[5 marks]

10. What is the APV of the proposed project in GBP, ignoring terminal value? [5 marks]

You are encouraged to conduct your calculations in an Excel spreadsheet. Afterwards, simply
copy and paste the relevant solutions/tables into a Word document before converting it to PDF.

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