The CFO of Expansion Group Ltd. has been presented with an opportunity to undertake a 7-year project in Turkey. As an emerging market, some incentives are available for foreign direct investment (FDI) in the country and she would like to evaluate this proposal.The following data is available for the evaluation of the project: The project investment is expected to cost £3,500,000, payable at the start of the project. Of this amount, £3,000,000 is a capital investment, with the remainder required for set up costs and other project related expenses. (Ignore depreciation for the purpose of this exercise.)The after-tax cash inflows have been estimated at £800,000 per year for the duration of the project. An opportunity cost of expansion in the UK has been identified and valued at £725,000.Costs for a visit to Turkey to evaluate the location and for meetings with the Turkish investment authority (ISPAT) have been recorded as £50,000.The company is publicly traded and the βeta of its stock is 1.2. The risk-free rate is 2% and the market rate of return is 6.5%.The relevant tax rate for the duration of the project is 20% (discount for FDI) and, under the conditions of the tax incentives, the company would be required to create a limited company in Turkey and operate there for a minimum of three years from the beginning of the project.Expansion Group Ltd. has sufficient retained earnings to fund the project. The CFO believes this project should be 100% funded with retained earnings, but no final decision has been made. a) Determine the relevant cash flows to be used in the investment evaluation. b) Calculate the Net Present Value (NPV) for the investment proposal and advise the CFO whether this project should be undertaken. (HINT: You will need to use the Capital Asset Pricing Model (CAPM) to determine the company’s required rate of return for the project.) c) Critically evaluate the choice of funds that the CFO wishes to use against other possible options and critically discuss any other issues that are applicable in this scenario.
The CFO of Expansion Group Ltd. has been presented with an opportunity to undertake a 7-year project in Turkey. As an emerging market, some incentives are available for foreign direct investment (FDI) in the country and she would like to evaluate this proposal.The following data is available for the evaluation of the project:
The project investment is expected to cost £3,500,000, payable at the start of the project. Of this amount, £3,000,000 is a capital investment, with the remainder required for set up costs and other project related expenses. (Ignore
- a) Determine the relevant cash flows to be used in the investment evaluation.
- b) Calculate the
Net Present Value (NPV) for the investment proposal and advise the CFO whether this project should be undertaken. (HINT: You will need to use theCapital Asset Pricing Model (CAPM) to determine the company’s required rate of return for the project.) - c) Critically evaluate the choice of funds that the CFO wishes to use against other possible options and critically discuss any other issues that are applicable in this scenario.
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Just for clarification purposes, is the 50 000 a sunken cost and should it have been accounted for in the cash flow? The question states 800 000 after tax, but the adjustments were taken into account hence the after tax is 760 000. Please clarify.
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