Project - Specific financial analysis: Exchange rate scenarios, cost of capital estimate
Project:
- USD 900m investment by a US chemical company in Brasil
- 10 years operational period, salvage value USD 50m in the end.
- Annual cashflow generation numbers in BRL: 450m in yr 1, annual increase by 50m
- reaching 900m BRL in yr 10.
- All numbers are after tax.
- Expected US avg annual inflation rate: 2% (10 yrs ahead)
- Expected Brasil avg annual inflation rate. 6% (10 yrs ahead)
- Spot USD/BRL exchange rate: 3, 1 BRL= 1 USD
I. Calculate 3 Exchange rate scenarios for the 10 years period for BRL/USD:
1. Base case: Inflation rate parity holds
2. Depreciation: by the 10th year, BRL real depreciation to USD reaches 40%
3. Appreciation: by the 10th year, BRL real appreciation to USD reaches 20%
Exchange rate values for the years 1-9 are exactly at inflation parity for the base case scenario, and anywhere between spot rate and 10th year rate for the Depreciation and Appreciation scenarios.
Probabilities assigned to the three scenarios are 40% (Base), 50% (Depreciation) and 10% (Appreciation).
II. Calculate the 10 yr forward BRL/USD exchange rate, implied by the 10 yr Brazilian and US bond yields.
US Treasury: 2.70%
Brazil 10 yr BRL bond: 10%
How does this number differ from the inflation parity rate? Which exchange rate scenario is closest to the implied forward rate?
III. Calculate the USD denominated cash flow scenarios for the project.
IV. Calculate/estimate one Cost of capital figure for the project in Brasil, for the USD cash flows.
- show separately the components of this discount rate (risk free, souvereign risk, industry risk, idiosyncratic). No need to separately calculate debt and equity components, assume equity financing only.
Calculate the USD NPV values for each scenarios and the probability-weighted overall value.
Calculate the IRRs for of the project for each scenario. (Internal rate of Return).
What is the maximum acceptable rate of the idiosyncratic risk component in order the project to be still doable in your judgement?
New scenario:
- You are financing 50% of the project from BRL debt.
- Calculate the cost of debt for the project, if default spread is 3%
- Calculate the WACC for the project, if Tax rate is 30%.
Recalculate the NPVs for each exchange rate scenario with the new WACC.
Attachment:- Assignment Files.rar