APV Method

Jones Graduate School Masa Watanabe
Rice University
INTERNATIONAL FINANCE
MGMT 657
ADJUSTED PRESENT VALUE APPROACH

TO INTERNATIONAL PROJECT VALUATION
Two Approaches to Project Valuation............................................................ 2

Adjusted Present Value (APV) ....................................................................... 3
Application of International APV................................................................... 4
Sensitivity Analysis ...................................................................................... 13
NPV Calculation of Blocked Funds ............................................................. 16
Practice Problem Set with Solutions............................................................. 17
International Finance Fall II, 2007
APV APPROACH IN INTERNATIONAL FINANCE
TWO APPROACHES TO PROJECT VALUATION

(1) NPV by WACC (weighted average cost of capital)
(2) APV (adjusted present value) ⇐ Today’s focus
Both are discounted-cash-flow (DCF) methods in that expected cash flows are
discounted by risk-adjusted discounting rates.
However, risk adjustment is different.
¾ The traditional NPV method (1) uses a single discount rate, WACC.
All risks are mingled in this single number.
¾ APV (2) applies multiple discounting rates to cash flows with different risk
characteristics.
Weighted Average Cost of Capital (WACC)

Discount after-tax cash flows from assets at the weighted average of after-tax
required returns on debt and equity.
E[CFt ]
NPV = ∑
t (1 + iWACC ) t
WACC advantages over APV:

Widely used.
Logical/natural method if debt/equity ratio is constant over time.
Is WACC appropriate for all occasions?

¾ Suppose depreciation tax shield constitutes a non-trivial portion of cash flows
from the project.
¾ Is it correct to discount cash flows from tax shield at the same rate as operating
cash flows that are much riskier?
2
ADJUSTED PRESENT VALUE (APV)

The key: separate operating cash flows from financing side effects.
VProject = VOperating CFs + VFinancing Side Effects
Discount less-risky financing side effects by lower rates.
¾ APV advantages over WACC:

Unbundles major components of value—drivers of value are much more apparent
under APV than WACC
Preserves information
Easier to value projects with changing characteristics
APV model for International Project1

¾ Value of operating CFs – discounted at the $ equity cost of capital
Convert foreign CFs to $
à RPPP ⇐ Usually easier; you typically have all inputs (inflation rates)
à IRP (long-dated forward rates) + Forward Parity = Uncovered IRP
Operating CFs include only incremental CFs and recognizes opportunity costs
(just like domestic APV)
à If a new manufacturing facility cannibalizes the existing sales (by foreign
affiliates), you must include lost sales
Blocked funds should be excluded from operating CFs
à Example: In the 1990’s, Chile required investors to “park” part of their
incoming money in non-interest bearing accounts for two years.
If there is foreign tax credit,
Marginal corporate tax rate = the larger of the parent’s or foreign subsidiary’s
¾ Value of financing side effects – discounted at a lower (debt) rate
Interest tax shield of the debt capacity created by the project’s asset
Depreciation tax shield
1
Lessard, Donald, 1985, “Evaluating International Projects: An Adjusted Present Value Approach,” in
Donald R. Lessard (ed.), International Financial Management: Theory and Application, 2nd ed. New York:
Wiley, 570-84.
3
Concessionary loan (subsidy loan) by the foreign government

Blocked/Restricted funds
APPLICATION OF INTERNATIONAL APV

The Centralia Corporation
(Adapted from Eun and Resnick, International Financial Management, 4th edition, in the course packet)
Background
¾ Midwestern manufacturer of small kitchen electrical appliances
¾ Exports microwave ovens to Spain
¾ Has a sales affiliate in Madrid
¾ Because of different electrical requirements in Western Europe, the ovens
manufactured for the Spanish market could not be used elsewhere in Europe
¾ Thus, historically concentrated on the Spanish market—till the creation of EU which
promoted commonality in electrical equipment
¾ Now the whole EU countries can be targeted. Centralia is thinking about constructing
a local manufacturing facility (a plant) in Spain
¾ This mode of cross-border capital budgeting is called foreign direct investment
(FDI)
Where is Centralia repositioning itself in the following table?
Revenues
Local Global
Local Domestic firms Exporters

(0) (+)
Operating
expenses
Global MNCs &
importers/exporters
Global Importers in globally
(-) competitive markets
(?)
4
Operating Information
¾ Current sales from export
Current sales are 9600 units a year, having been increasing at 5% annually
Currently receives $180 per unit exported
Contribution margin is $35 per unit
¾ New plant
Initial sales forecast of 28,000 units, increasing at 7% per year
All sales invoiced in euros
When the plant begins operation, units will be priced at €200 per unit
Estimated production cost of €160 per unit
¾ Both sales price and production costs are expected to keep pace with inflation
Financial Market Information

¾ Spot FX 1.20$/€
¾ Inflation forecast: 6% per annum in Spain, 3% in the U.S.
Used for both revenue-cost projection and spot rate forecast (RPPP)
¾ Borrowing rate for Centralia: 8% in dollars, 9% in euros
¾ With unemployment rate exceeding 19%, the Spanish government has promised to
offer funds up to €3,500,000 at 6% to attract business ⇐ Concessionary loan
¾ Centralia estimates all-equity $ cost of capital at 11% ⇐ Disc. rate for risky CF
5
Cost of Constructing the Manufacturing Plant

¾ Estimated cost of construction: €5,40,000
¾ Suppose the manager believes that the optimal long-run debt/asset ratio for the firm
is 30%
Implies an additional debt capacity of
€5.4 million × 30% = €1.62 million
(= $1.944 million at spot FX 1.20$/€)
created by the project.
The marginal corporate tax rate is 35% in both Spain and the U.S.
¾ The Madrid sales affiliate has accumulated €550,000 from its operations
This can be used to partially finance the construction cost
The fund was earned under special tax concessions offered during the initial years
of the sales operation, and taxed at a marginal rate of 20%
If repatriated, an additional tax will be due, but with a foreign tax credit given
for the Spanish taxes already paid (so the difference, 35% – 20%=15%, is due)
¾ The plant can be depreciated to zero over 8 years straight-line
Let’s begin the project valuation!

Note: the spread sheet is available on Owlspace. Download it to confirm the calculations
below.
6
(i) PV of After-tax Operating CFs

¾ Operating cash flows are discounted at a rate consistent with the risk.
¾ The firm will receive these cash flows regardless of whether it is levered or
unlevered Î Use equity cost of capital
(a) (b) (c) (d) (e) (f) (g)

Quantity lost Incremental $
Year (t) E[St] Quantity $ profits sales Lost $ profits profits After-tax PV
1 1.1660 28,000 1,384,320 (10,080) (363,384) 1,020,936 597,845
2 1.1330 29,960 1,525,659 (10,584) (393,000) 1,132,659 597,540
3 1.1010 32,057 1,681,429 (11,113) (425,029) 1,256,400 597,135
4 1.0698 34,301 1,853,103 (11,669) (459,669) 1,393,434 596,634
5 1.0395 36,702 2,042,305 (12,252) (497,132) 1,545,172 596,040
6 1.0101 39,271 2,250,824 (12,865) (537,648) 1,713,175 595,357
7 0.9815 42,020 2,480,633 (13,508) (581,467) 1,899,166 594,587
8 0.9537 44,962 2,733,906 (14,184) (628,856) 2,105,049 593,734
4,768,871
(a) Expected future spot rate

Use RPPP
⎛ 1+π $ ⎞
t
⎛ 1.03 ⎞
E[ S t ] = S 0 ⎜⎜ ⎟ = 1.20⎜
euro ⎟ ⎟
⎝1 + π ⎠ ⎝ 1.06 ⎠
(b) Initially 28000 units, grows at 7% per year
(c) Profit (operating CF) is €200 – €160 = €40 per unit, increases at the inflation rate
⇒ €40 × (Spanish inflation 1.06)t × (b) Quantity × (a) FX rate
(d) Lost sales from the existing sales affiliate (opportunity cost)
= -9600 × 1.05t (9600 units growing at 5%)
(e) = (d) × (Current contribution margin $35) × (US inflation 1.03)t
(f) = (c) + (e)
(g) Discount operating CFs (risky CFs) by the all-equity cost of capital
⇒ (f) × (1- marginal tax rate 35%) / 1.11t
It is straightforward to incorporate a non-zero terminal value for future cash flows

beyond year 8 (see later in this note). The management’s view can be reflected.
7
(ii) PV of Depreciation Tax Shields

¾ Depreciation reduces taxable income.
¾ The tax benefit due to depreciation is less risky than operating cash flows, and
therefore is discounted at a debt rate (borrowing rate).
(a) (b) (c) (d)

Depreciation Depreciation tax
Year (t) E[St] (euro) shield ($) PV
1 1.16604 675,000 275,476 255,071
2 1.13304 675,000 267,680 229,492
3 1.10097 675,000 260,104 206,479
4 1.06981 675,000 252,743 185,773
5 1.03953 675,000 245,590 167,144
6 1.01011 675,000 238,639 150,383
7 0.98152 675,000 231,885 135,303
8 0.95374 675,000 225,322 121,735
1,451,380
(b) Straight-line depreciation to zero for 8 years

€5,400,000 / 8 = €675,000
(c) = (b) × marginal tax rate 35% × (a)
(d) = (c) / 1.08t. Discount the tax shield by the debt rate
8
(iii) NPV of Concessionary Loan

¾ A concessionary loan is offered at a preferred rate relative to the market rate.
¾ The loan represents a subsidy that the host country is willing to extend to the
multinational corporation (MNC) if the investment is made.
¾ This subsidy is given by the NPV of the concessionary-loan cash flows discounted at
the normal (market) interest rate (the NPV will be positive).2
(a) (b) (c) (d) (e) (f)

Remaining Interest
Principal Principal Payment Total
Year (t) E[St] (euro) Payment (euro) (euro) Payment ($) PV
0 1.2 3,500,000 4,200,000
1 1.16604 3,062,500 (437,500) (210,000) (755,009) (699,083)
2 1.13304 2,625,000 (437,500) (183,750) (703,899) (603,480)
3 1.10097 2,187,500 (437,500) (157,500) (655,077) (520,021)
4 1.06981 1,750,000 (437,500) (131,250) (608,454) (447,232)
5 1.03953 1,312,500 (437,500) (105,000) (563,946) (383,812)
6 1.01011 875,000 (437,500) (78,750) (521,470) (328,615)
7 0.98152 437,500 (437,500) (52,500) (480,947) (280,628)
8 0.95374 - (437,500) (26,250) (442,299) (238,960)
(3,500,000) 698,169
(b) = (b) from the previous year – (c) annual principal payment
(c) Equal payment (amortization) over 8 years (total €3,500,000)
(d) = (b) from the previous year × preferred rate of 6% (lower than the market rate 8%)
(e) = [(c) annual principal repayment + (d) interest] × (a)
(f) = (e) / 1.08t (discounted at the market rate of 8%)
Notice that NPV is positive (as it should be).
2
This is because, in general, the PV of the future principal and interest payments of a loan discounted at its
interest rate is equal to its principal (even if there are unequal installments).
9
(iv) PV of Interest Tax Shields

¾ Calculation of interest tax shields should be based on the additional debt capacity.
The firm has an optimal capital structure. This implies an additional debt
capacity created by the project, however the project is financed.
Investment and financing decisions are separate. The financing of each project
can divert from the optimal debt ratio. However, the firm’s capital structure
should revert toward it in the long run.
Using the whole concessionary loan amount creates an undesired incentive to
deviate from its optimal capital structure.
(a) (b) (c) (d) (e) (f)
Borrowing Interest
Interest capacity / Payment
Payment Concessionary Considered Interest Tax
Year (t) E[St] (euro) Loan (euro) Shield ($) PV
1 1.16604 210,000 0.4629 97,200 39,669 36,730
2 1.13304 183,750 0.4629 85,050 33,728 28,916
3 1.10097 157,500 0.4629 72,900 28,091 22,300
4 1.06981 131,250 0.4629 60,750 22,747 16,720
5 1.03953 105,000 0.4629 48,600 17,682 12,034
6 1.01011 78,750 0.4629 36,450 12,887 8,121
7 0.98152 52,500 0.4629 24,300 8,348 4,871
8 0.95374 26,250 0.4629 12,150 4,056 2,191
131,883
(b) From Part (iii) Column (d)
(c) Only that portion of the interest payment on the concessionary loan that corresponds to the
debt capacity should be used to calculate the interest tax shield.
(debt capacity) / (concessionary loan)
= €5.4 million × 30% / €3.5 million
= 46.29%
(d) = (b) € interest payment × (c)
This is the interest payment that would result if the project were financed with the optimal
capital structure.3
(e) = (a) × (d) × marginal tax rate of 35%
(f) = (e) / 1.08t.
3
Booth (1982) shows that tax shields calculated using the concessionary loan rates are also theoretically
correct. Booth, Lawrence D., “Capital Budgeting Frameworks for the Multinational Corporation,” Journal
of International Business Studies, Fall 1982, 113-23.
10
(v) Freed-up Restricted Remittances

¾ The preferred tax rate of 20% was granted on the condition that the funds are
pooled within Spain.
Works similarly as blocked funds forced by some emerging-market governments,
but in this case it is Centralia’s option to repatriate the funds.
¾ Let us compute the additional tax resulting from the remittance of €550,000 to the
parent if the project is not taken.
¾ First, gross up the after-tax figure by the tax rate to get the pre-tax figure that the
Madrid affiliate has accumulated:
€550,000 / (1 - 20%) = €687,500 = $825,000 at spot FX
¾ A 20% tax has already been paid to the Spanish government. If the funds are
repatriated, an additional 15% (=35% – 20%) is due at home because of the foreign
tax credit:
$825,000 × 15% = $123,750.
¾ If project is taken and no remittance occurs, tax savings of $123,750.
⇒ Applied to cover a portion of the plant cost
11
(vi) Finally, put them together and compute APV
4,768,871 PV of After-tax Operating CFs

1,451,380 PV of Depreciation Tax Shields
698,169 NPV of Concessionary Loan
131,883 PV of Interest Tax Shields
123,750 Freed-up Restricted Remittances
(6,480,000) Initial Investment: $ Cost of Plant
APV = 694,052
Summary
¾ Operating CFs and depreciation tax shields drive the value of this project
¾ Concessionary loan is the key: without it, APV is very close to zero, and caution is
needed.
12
SENSITIVITY ANALYSIS
1. Terminal Value and Growth Rate
Above, we used a very conservative terminal value of zero (in year 8) in Step (i).
Alternatively, we could assume some positive number based on the Gordon growth
formula (growth rate = g, discount rate = r):
C
PV =
r−g
C(1+g) C(1+g)2 C(1+g)3

……
t=0 1 2 3
The formula for the profit in column (c) of Step (i) is

(c) €40 × (Spanish inflation 1.06)t × (b) Quantity × (a) FX rate
t
⎛ 1.03 ⎞
= 40 × 1.06t × 28000 × 1.07t-1 × 1.20⎜ ⎟ .
⎝ 1.06 ⎠
So, PV of the after-tax profit is
PV(Profit(t)) = (c) × (1 – 0.35) / 1.11t
40 ⋅ 28000 ⋅ 1.20 ⋅ 0.65 ⎛ 1.07 ⋅ 1.03 ⎞

t
= ⎜ ⎟
1.07 ⎝ 1.11 ⎠
Easy to confirm that (substitute t = 8 above)
PV(Profit(8)) = 771,104.14
From there, the PV of profit annually changes by a factor in the bracket.
So, in the Gordon formula, set
g = 1.07×1.03 – 1 = 0.1021,
r = 0.11.
Thus, the total PV of profits beyond year 8 is
Sum PV(Profits) = 771,104.14/(0.11 – 0.1021) = 97,608,119.
13
Next, the formula for the opportunity cost in lost sales from the existing sales
affiliate in column (e) is
(e) Lost profit = (Lost quantity) × (Contribution margin $35) × (US inflation 1.03)t
= -(9600 × 1.05t) × 35 × 1.03t
So, PV of the after-tax lost profit is
PV(Lost profit(t)) = (e) × (1 – 0.35) / 1.11t
⎛ 1.05 ⋅ 1.03 ⎞
t
= − 9600 ⋅ 35 ⋅ 0.65⎜ ⎟
⎝ 1.11 ⎠
Easy to confirm that (again set t = 8 above)
PV(Lost profit(8)) = -177,370.34
In the Gordon formula, set
g = 1.05×1.03 – 1 = 0.0815
r = 0.11
Thus, the total PV of lost profits beyond year 8 is
Sum PV(Lost profits) = -177,370.34/(0.11 – 0.0815) = -6,223,521.
The after-tax PV in column (g) beyond year 8 will be the sum of these two numbers:
Increase in APV = 97,608,119 – 6,223,521 = 91,384,598.
This is a gigantic number. It is primarily driven by the bullish sales growth rate of
7%.
Instead, assume conservatively that the sales growth rate is 0% beyond year 8 and
repeat the analysis.
Sum PV(profits) = 771,104.14/(0.11 – 0.03) = 9,638,802.
There is no change in the sum of the PV of lost profits. Thus, the increase in APV
under zero growth (beyond year 8) is only
Increase in APV = 9,638,802 – 6,223,521 = 3,415,281.
14
2. Spot rate
Download the Excel sheet on the course web site. Confirm that if the spot rate is, instead
of $1.20/€,
$1.30/€ Î APV = $881,637
$1.10/€ Î APV = $506,467
Change in APV per a 1¢ spot-rate fluctuation is
(881,637 – 506,467)/(1.30 – 1.10)/100 = $18,758.50.
This is the sensitivity of the project APV with respect to the spot rate, i.e., this is the
project delta.
Question. Could you have expected that delta > 0?
3. Other numbers
Try changing other key numbers (those under management’s discretion or uncertain
variables) and see how the project APV is affected. For example,
expected domestic and foreign inflation rates
price and cost of oven,
$ cost of capital,
$ borrowing rate,
optimal debt ratio,
cost of plant, etc.
Have fun!
15
NPV CALCULATION OF BLOCKED FUNDS

Use the APV framework to consider the effect of blocked funds.
Suppose:
¾ Consider an emerging market whose currency is F.
¾ Operating CFs from years 1 through 3 are F2000, F2200, F2400
¾ 50% of operating CFs (F1000, F1100, F1200 for years 1 through 3) blocked by the
government with no interest until the end of year 3
¾ The spot rate is 1.30$/F.
¾ Interest rates: 2% for $, 5% for F.
¾ Appropriate discounting rate is 18%
First, compute the NPV assuming the funds were not blocked:
Year 0 1 2 3
(a) CF (F) 1000 1100 1200
(b) Spot rate ($/F) 1.3 1.26 1.23 1.19
(c) CF ($) 1262.9 1349.5 1430.1
(d) PV factor 1 0.847 0.718 0.609
(e) PV of unblocked funds ($) 1070 969 870
(f) NPV ($) 2909.8
t
⎛ 1.02 ⎞
(b) UIRP: E[ ST ] = S t ⎜ ⎟
⎝ 1.05 ⎠
(c) CF ($) = (a) × (b)
(d) PV factor = 1/1.18t
Next, compute the NPV when the funds are blocked: the total cash flow occurs at the end
of year 3.
(ii) Blocked Funds
Year 0 1 2 3
(g) Blocked CF (F) 3300
(h) PV of unblocked funds ($) 2393.6
(i) NPV ($) 2393.6
(h) PV ($) = (g) × (b) spot rate × (d) PV factor
Opportunity cost of the blocked funds is $2,909.8 – $2,393.6 = $516.2.

Apply APV:
⇒ VPROJECT WITH SIDE EFFECT = VPROJECT WITHOUT SIDE EFFECT – $516.2
16
PRACTICE PROBLEM SET WITH SOLUTIONS
Cross-border Capital Budgeting III

Solve the following end-of-chapter problems from Butler:
16.3 (replace the currency BFr with euro). Note that the formula in Part c is the
Gordon Growth formula.
16.4 (Footsie is FTSE, the UK stock index)
16.5, 16.6. In Part b of these questions, assume that the debt values shown there
create the optimal debt ratio. In Part c, note that the perpetuity does not grow, and that
it requires the same initial investment as in Part a.
Suggested Solutions
16.3 a. The required return on Oilily’s equity within the French market is rF+β(E[rM]-rF) = 5% +
(1.4)(11%-5%) = 13.4%. Oilily’s weighted average cost of capital is iWACC = (B/VL)iB(1-
TC)+(S/VL)iS = (0.4)(7%)(1-0.33)+(0.6)(13.4%) = 9.916%.
b. Required return on Oilily’s stock is r = 5%+(1.2)(12%-5%) = 13.4% for an international
investor. Using international sources, Oilily’s cost of capital is iWACC = (B/VL)iB(1-TC) +
(S/VL)iS = (½)(6%)(1-0.33) + (½)(13.4%) = 8.710%.
c. Assume that the operating cash flow is before interest expense and in euros (rather than
Belgian francs). In France, Oilily’s value is V0 = CF1/(i-g) = (€10million)/(0.09916-0.04) =
€169,033,130. If the global market, Oilily’s value is V0 = CF1/(i-g) = €10,000,000/(0.08710-
0.04) = €212,314,225. Oilily can increase its value by over 25% by financing in international
markets because of this market’s higher tolerance for debt and lower required returns.
16.4 a. Grand Pet’s debt ratio is (B/VL) = 33/(33+100) = 0.25. The required return on Grand Pet’s
equity is r = rF + β(E[rM]-rF) = 5%+(1.2)(15%-5%) = 17%. Grand Pet’s weighted average cost
of capital is: iWACC = (B/VL)iB(1-TC)+(S/VL)iS = (0.25)(6%)(1-0.33) + (0.75)(17%) = 13.755%.
b. The debt ratio is now (B/VL) = 50/(50+100) = 0.33. The required return on Grand Pet’s equity
in international markets is r = rF+β(E[rW]-rF) = 5%+(0.8)(10%-5%) = 9%. Using international
sources of capital, Grand Pet’s cost of capital is: iWACC = (B/VL)iB(1-TC)+(S/VL)iS =
(0.33)(5%)(1-0.33) + (0.67)(9%) = 7.1355%.
c. Let’s assume that the £1 billion operating cash flow is before interest expense, so that the
weighted average cost of capital is the appropriate discount rate on these cash flows to debt and
equity. In the U.K. market, Grand Pet’s value is
V0 = CF1 / (i-g) = £1,000,000,000/(0.13755-0.03) = £9,298,000,000.
If Grand Pet can raise funds in the global market, Grand Pet’s value is
V0 = CF1 / (i-g) = £1,000,000,000/(0.07117-0.03) = £24,291,000,000.
Grand Pet can increase its value by over 150% by raising funds internationally.
17
16.5 Let’s assume that the cash flows are in euros (rather than Belgian francs).
a. All-equity value is APV = VU-CF0 = (CF1 )/(1+iU)-Initial investment
= (BFr112 million/1.10)-BFr100 million = BFr1,818,182.
b. Borrowing €50 million at 6% results in an interest payment of iBB = €3 million. The present
value of the interest tax shield is (TCiBB)/(1+iB) = (€3M×0.33/1.06) ≈ €933,962. The APV of
the investment is then €1,818,182 + €933,962 = €2,752,144.
c. All-equity value is APV = VU-CF0 = €12 million/0.10-€100 million = €20,000,000. The value
of the perpetual interest tax shield is €3M×0.33/0.06 = €16,500,000 (or TCiBB/iB=TCB =
(0.33)(€50 million)). The levered firm is worth the sum, €36,500,000.
16.6 a. All-equity value is

APV = VU-CF0 = (CF1 )/(1+iU)-Initial investment
= (£108 million/1.08)-£100 million = £0.
b. APV = VU + PV(financing side effects)-Initial investment.
Borrowing £25 million at 6% results in interest of iBB = £1.5 million. The annual interest tax
shield is TCiBB = £1.5M×0.33=£495,000. The PV of the tax shield is (TCiBB)/(1+iB)
495,000/1.06 = £466,981. Since the unlevered investment has zero value, £466,981 is the APV
of the one-year investment after including the interest tax shield from the debt.
c. As a perpetuity, the all-equity value is still £8M/0.08 – £100M=£0. The value of the perpetual
interest tax shield is £495,000/0.06 = £8.25M. The levered value is:
APV = 0 + £8.25M = £8.25M.
The value continues to arise solely from the interest tax shield.
18

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Jones Graduate School Masa Watanabe

ADJUSTED PRESENT VALUE APPROACH

Two Approaches to Project Valuation............................................................ 2

TWO APPROACHES TO PROJECT VALUATION

Weighted Average Cost of Capital (WACC)

 WACC advantages over APV:

 Is WACC appropriate for all occasions?

ADJUSTED PRESENT VALUE (APV)

¾ APV advantages over WACC:

APV model for International Project1

 Concessionary loan (subsidy loan) by the foreign government

APPLICATION OF INTERNATIONAL APV

 Where is Centralia repositioning itself in the following table?

Local Domestic firms Exporters

Financial Market Information

Cost of Constructing the Manufacturing Plant

Let’s begin the project valuation!

(i) PV of After-tax Operating CFs

(a) (b) (c) (d) (e) (f) (g)

(a) Expected future spot rate

 It is straightforward to incorporate a non-zero terminal value for future cash flows

(ii) PV of Depreciation Tax Shields

(a) (b) (c) (d)

(b) Straight-line depreciation to zero for 8 years

(iii) NPV of Concessionary Loan

(a) (b) (c) (d) (e) (f)

Notice that NPV is positive (as it should be).

(iv) PV of Interest Tax Shields

(v) Freed-up Restricted Remittances

(vi) Finally, put them together and compute APV

4,768,871 PV of After-tax Operating CFs

C(1+g) C(1+g)2 C(1+g)3

 The formula for the profit in column (c) of Step (i) is

40 ⋅ 28000 ⋅ 1.20 ⋅ 0.65 ⎛ 1.07 ⋅ 1.03 ⎞

 Question. Could you have expected that delta > 0?

NPV CALCULATION OF BLOCKED FUNDS

Opportunity cost of the blocked funds is $2,909.8 – $2,393.6 = $516.2.

PRACTICE PROBLEM SET WITH SOLUTIONS

Cross-border Capital Budgeting III

16.6 a. All-equity value is

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The formula for the profit in column (c) of Step (i) is

Question. Could you have expected that delta > 0?