Include work for all questions:
1. Texas Co. (TC) established a subsidiary in Russia two years ago. Under its original plans, TC intended to operate the subsidiary for a total of four years. Exchange forecasts suggest the ruble will likely depreciated from the current level of $0.033 to $0.028 to $0.025 over the next few years. TC could sell the subsidiary today for 5 million rubles to a potential acquirer. If TC continues to operate the subsidiary, it will generate cash flows of 3.5 million rubles next year and 4.5 million rubles in the following year. These cash flows would be remitted back to the parent in the U.S. The required rate of return of the project is 15 percent.
Should TC continue operating the Russian subsidiary?
2. Wilmington Inc. is considering the acquisition of a unit from the French government.
- Initial outlay will be $4 million dollars
- All earnings reinvested
- Time period 8 years and at that time will sell acquisition for 12 million euros after taxes
- Spot rate for euro is $1.20
- Risk free U.S. intersect rate regardless of maturity is 5 percent
- Risk free interest rate on euros regardless of maturity is 7 percent
- Interest rate parity holds
- Cost of capital is 20 percent
- Cash will be used for acquisition
a. Using the parameters above, Determine the NPV.
b. Rather than use all cash, Wilmington Inc. could partially finance the acquisition. It could obtain a loan of 3 million euros today that would be used to cover a portion of the acquisition. In this case, it would have to pay back a lump sum total of 7 million euros at the end of 8 years to repay the loan. There are no interest payments on this debt. This financing deal is structured such that none of the payment is tax-deductible.
Determine the NPV if Wilmington uses the forward rate instead of the spot rate to forecast the future spot rate of the euro, and elects to partially finance the acquisition.