Week 29 Seminar Question; Blo Inc. is a company based in the USA.
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Week 29 Seminar Question; Blo Inc. is a company based in the USA.

Blo Inc. is a company based in the USA. It is considering a project investment in the UK comprising the acquisition of new machinery which it hopes will increase its profits.

Week 29 Seminar Question

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Blo Inc. is a company based in the USA. It is considering a project investment in the UK comprising the acquisition of new machinery which it hopes will increase its profits.

The initial investment in the machinery would be £10 million immediately and the project is expected to last for four years.

Sales would increase by £3 million per annum in current terms. Sales prices are expected to rise by 5% per annum.

Purchases of raw materials and labour are expected to be £1 million each in current terms, but expected to rise by 3% and 2% respectively.

Investment in machinery receives tax allowable depreciation of 25% per annum. Allowances are receivable one year in arrears.

The machinery will be sold at the end of the project for £4 million, in year 4 prices.

Corporation tax in the UK is 30% and in the US is 25%. Corporation tax is payable in the following year in both countries.

The project will require an injection of working capital immediately of £2 million and will be released at the end of the project. The working capital requirement is expected to rise by 1% per annum.

The real cost of capital of Blox Inc. is 10%

General inflation in the UK is predicted to be 2% per annum, and in the US 4%, throughout the duration of the project.

The current spot rate for the £ to the \$ is £1 = \$1.505.

Required:

(i)  Calculate the annual discounted cash flows in \$ millions, using the nominal rate method.

(ii) State the net present value of the project and whether you recommend for the project to commence.

(TOTAL: 50 MARKS AVAILABLE)

Note: In this question you are given the real cost of capital, you have to calculate the nominal cost of capital.

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