A US company is considering building a UK plant. What is the APV? Blow are the i

Question

A US company is considering building a UK plant. What is the APV?

Blow are the information provided:

1. Initial capital outlay: GBP 20 million on plant and machinery.

2. The plant will produce 60,000 items in year 1, and production will increase at 10% a year up to and including year 4. This is incremental sales.

3. The current price of the product is GBP 250 per item and this is expected to increase in line with inflation.

4. The current variable cost of production is GBP 140 per item and, again, this is expected to increase in line with inflation. Of this, GBP 30 per product is sourced from the Home company in America. A profit margin of 25% is made on these sales.

5. The expected inflation rate in the US and UK respectively are 3% and 5%.

6. The corporation tax rate is 40% in the UK and 35% in the US.

7. The project is assumed to have a beta of 1 and the real rate of interest is assumed to be approximately 1 % in both the US and the UK. A market risk premium of 8% can be applied.

8. Plant and machinery in the UK is assumed to be written down on a straight-line basis over 4 years with no residual value.

9. The current spot rate is USD/GBP =2.00.

10. If the real interest rate is 1%, then the risk-free rate is approximately 6%, and the cost of capital 14% in the UK

Explanation / Answer

Statement Adjusted present Value (APV)

Note : 1. Assumed Cost of equity is 14% in UK. 2. Profit earned on supply from US is deducted from from cost so as to get a better result of the project.

Year Sales Unit Selling Price Variable Cost per unit other than sourced from US Variable Cost per unit, sourced from US, at cost Total Variable Cost Contribution per unit Total Contribution Tax After Tax Contribution or Free Csh flow Dpreciation tax Shield on depreciation Free Cash Flows DF @14% PV 0 -20000000 -20000000 1.000 -20000001 1 60000 250.00 110.00 22.50 132.50 117.50 7050000 2820000 4230000 0 0 4230000 0.877 4229999 2 66000 262.50 115.50 23.18 138.68 123.83 8172450 3268980 4903470 5000000 2000000 6903470 0.769 6903469 3 72600 275.63 121.28 23.87 145.15 130.48 9472830 3789132 5683698 5000000 2000000 7683698 0.675 7683697 4 79860 289.41 127.34 24.59 151.93 137.48 10979244 4391698 6587546 5000000 2000000 8587546 0.592 8587546 APV 7404710

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