Miller is evaluating a plan to brew and market a new porter beer in Europe. The

Question

Miller is evaluating a plan to brew and market a new porter beer in Europe. The new beer will be test marketed for 1 year in Belgium, with up front costs of                     (euro)20 million. No profits will be generated by the test market. There is a 50% chance that the test phase will warrant an additional (euro)400 million                     investment. The expected annual after-tax cash flow for the new beer in Europe is expected to be (euro)100 million per year for 15 years. If the test phase fails,                     the project will be abandoned. A required rate of return of 12.5% is required for the (euro)400 million investment. Since the test-market is speculative, the                     CFO believes that the firm should use a discount rate of 25% to determine the NPV for the decision to test market the product. The exchange rate between the                     DOLLAR and EURO is $1.6/(euro)1. Assuming the risk-free EURO-denominated interest rate is 4.5% per year and the risk-free US interest rate is 1.5% per year,                     determine the NPV for the investment in test marketing the product.

Explanation / Answer

IF THE TEST PHASE SUCCEDS

YEARS CASHFLOWS(IN EURO MILLIONS) PRESENT VALUE @ 25% (IN EURO MILLIONS)

0 (20) (20)

1 (400) (256)

2 100 64

3 100 51.2

4 100 40.96

5 100 32.77

6 100 26.21

7 100 20.97

8 100 16.78

9 100 13.42

10 100 10.74

11 100 8.59

12 100 6.87

13 100 5.5

14 100 4.4

15 100 3.52

16 100 2.81

NPV= 32.74 (IN EURO MILLIONS)

IF THE TEST FAILS, THE PROJECT WILL BE ABANDONED AND THERE WILL BE ONLY ONE CASH OUTFLOW OF EURO 20 MILLION

THEREFORE NPV = (20) ( IN EURO MILLIONS)

PARTICULARS PROBALITY NPV

a]TEST SUUCCEDS 0.5 32.74

b]TEST FAILS 0.5 (20)

THEREFORE, PROBABLE NPV OF THE PROJECT = 32.74*0.5 + (20)*0.5

=EURO 6.37 MILLION

SINCE EVERY FIGURE IS IN EURO WE CAN EVALUTE THE PROJECT

SINCE PROBABLE NPV IS POSITIVE THE COMPANY SHOULD ACCEPT THE PROJECT

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