Question 1

Instruction 18.1:
Use the information to answer the following question(s).
The Velo Rapid Revolutions Inc. ,a company that produces bicycles,elliptical trainers,scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe.The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed,but rather,must be depreciated over the life of the asset).Because this would be a new product,they will not be replacing existing equipment.The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years,however;expenses will also increase by euro 200,000 per year.(Note: Assume the after-tax operating cash flows in years 1-5 are equal,and that the terminal value of the project in year 5 may change total after-tax cash flows for that year. )The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000.The firm's required rate of return is 12% and they are in the 40% tax bracket.Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment,and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years).The current spot rate is $0.95/euro ,and the expected inflation rate in the U.S.is 4% per year and 3% per year in Europe.
-Refer to Instruction 18.1.What are the annual after-tax cash flows for the Velo Rapid Revolutions project?
A)€400,000
B)€240,000
C)€120,000
D)€360,000

Accepted Answer

To calculate the annual after-tax cash flows, we need to use the following formula:
ATCF = (Revenue - Expense - Depreciation)(1 - tax rate) + Depreciation
NWC at Year 0 = NWC at Year 5 = €100,000

Year 0:
Initial Investment = €1,500,000 (€1,200,000 equipment cost + €300,000 installation cost)
NWC Investment = €100,000
Total Investment = €1,600,000

Year 1-5:
Revenue = €600,000 per year
Expense = €200,000 per year
Depreciation = €260,000 per year (€1,200,000 equipment cost + €300,000 installation cost - €500,000 salvage value, all divided by 5 years)
Tax rate = 40%

ATCF = (€600,000 - €200,000 - €260,000)(1 - 0.4) + €260,000
ATCF = €216,000

Year 5:
Revenue = €600,000
Expense = €200,000
Depreciation = €60,000 (remaining book value of equipment)
Tax rate = 40%
Salvage value = €500,000

ATCF = (€600,000 - €200,000 - €60,000)(1 - 0.4) + €60,000 + €500,000 - €100,000 (recover initial NWC)
ATCF = €506,000

Annual after-tax cash flows for Years 1-5:
€216,000 per year
+€506,000 in Year 5
=€1,290,000 over 5 years

Average Annual after-tax cash flows:
€1,290,000 / 5 years
=€258,000 per year

Therefore, the best choice is D with annual after-tax cash flows of €258,000 per year.

Question 2

When estimating a firm's cost of equity capital using the CAPM,you need to estimate:
A)the risk-free rate of return.
B)the expected return on the market portfolio.
C)the firm's beta.
D)all of the above

Accepted Answer

All three components (risk-free rate of return, expected return on the market portfolio, and the firm's beta) are necessary inputs in the CAPM formula to estimate a firm's cost of equity capital.

Question 3

When determining a firm's weighted average cost of capital (WACC)which of the following terms is NOT necessary?
A)the firm's weight of equity financing
B)the risk-free rate of return
C)the firm's weight of debt financing
D)All of the above are necessary to determine a firm's WACC.

Accepted Answer

The risk-free rate of return is not directly necessary for calculating a firm's weighted average cost of capital (WACC). WACC is calculated using the cost of equity, the cost of debt, and their respective weights in the firm's capital structure. The risk-free rate is a component of the cost of equity (as per the Capital Asset Pricing Model), but it is not a direct input in the WACC formula itself.

Question 4

Instruction 18.1:
Use the information to answer the following question(s).
The Velo Rapid Revolutions Inc. ,a company that produces bicycles,elliptical trainers,scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe.The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed,but rather,must be depreciated over the life of the asset).Because this would be a new product,they will not be replacing existing equipment.The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years,however;expenses will also increase by euro 200,000 per year.(Note: Assume the after-tax operating cash flows in years 1-5 are equal,and that the terminal value of the project in year 5 may change total after-tax cash flows for that year. )The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000.The firm's required rate of return is 12% and they are in the 40% tax bracket.Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment,and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years).The current spot rate is $0.95/euro ,and the expected inflation rate in the U.S.is 4% per year and 3% per year in Europe.
-Refer to Instruction 18.1.What is the initial investment for the Velo Rapid Revolutions project?
A)$1,500,000
B)€1,600,000
C)$1,600,000
D)€1,500,000

Accepted Answer

The answer of Instruction 18.1:
Use the information to answer the...

Question 5

A criticism of adjusting the discount rate to account for political risk is that adjusting the discount rate for political risk penalizes early cash flows too heavily while not penalizing distant cash flows enough.

Accepted Answer

Adjusting the discount rate for political risk can lead to a higher discount rate for early cash flows, as they are more exposed to political risk, and a lower discount rate for distant cash flows, as the risk is seen to decrease over time. This can lead to a heavier penalization of early cash flows and a lighter penalization of distant cash flows, which can be seen as a criticism of the practice.

Question 6

Instruction 18.1:
Use the information to answer the following question(s).
The Velo Rapid Revolutions Inc. ,a company that produces bicycles,elliptical trainers,scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe.The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed,but rather,must be depreciated over the life of the asset).Because this would be a new product,they will not be replacing existing equipment.The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years,however;expenses will also increase by euro 200,000 per year.(Note: Assume the after-tax operating cash flows in years 1-5 are equal,and that the terminal value of the project in year 5 may change total after-tax cash flows for that year. )The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000.The firm's required rate of return is 12% and they are in the 40% tax bracket.Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment,and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years).The current spot rate is $0.95/euro ,and the expected inflation rate in the U.S.is 4% per year and 3% per year in Europe.
-Refer to Instruction 18.1.What is the NPV of the European expansion if Velo Rapid Revolutions first computes the NPV in euros and then converts that figure to dollars using the current spot rate?
A)$1,520,000
B)$1,684,210
C)-$75,310
D)-$71,544

Accepted Answer

The answer of Instruction 18.1:
Use the information to answer the...

Question 7

When determining a firm's weighted average cost of capital (wacc)which of the following terms is NOT necessary?
A)the firm's tax rate
B)the firm's cost of debt
C)the firm's cost of equity
D)All of the above are necessary.

Accepted Answer

All three terms, the firm's tax rate, cost of debt, and cost of equity, are necessary to calculate the weighted average cost of capital (WACC). The WACC formula incorporates both the cost of debt and equity, and the tax rate is used to calculate the after-tax cost of debt.

Question 8

When a multinational firm invests abroad,it is common to develop two capital budgets: one from the project viewpoint,and one from the parent viewpoint.

Accepted Answer

This is true because when a multinational firm invests abroad, it needs to evaluate the project's financial viability (such as expected cash flows, investment costs, and risks) from the project viewpoint. Simultaneously, it also needs to assess the impact of the investment on the parent company's cash flows, financial performance, risk profile, and strategic objectives from the parent viewpoint. Therefore, two separate capital budgets are typically developed.

Question 9

________ is the risk that a foreign government will place restrictions such as limiting the amount of funds that can be remitted to the parent firm,or even expropriation of cash flows earned in that country.
A)Exchange risk
B)Foreign risk
C)Political risk
D)Unnecessary risk

Accepted Answer

Political risk refers to the risk of unexpected changes in a country's political environment that may negatively impact the operations and profitability of foreign companies operating in that country. This includes the risk of government-imposed restrictions and expropriation of assets.

Question 10

Because international capital budgeting is so difficult,time consuming,expensive,and uncertain,firms generally forego any type of additional sensitivity analysis after completing a base-case scenario.

Accepted Answer

Sensitivity analysis is a crucial step in international capital budgeting as it helps firms to identify the impact of different variables on their investment decisions. Foregoing sensitivity analysis can lead to flawed decision-making and can have significant financial consequences. Therefore, firms should not skip sensitivity analysis even though it may be time-consuming, expensive, and uncertain.

Question 11

Generally speaking,a firm wants to receive cash flows from a currency that is ________ relative to their own,and pay out in currencies that are ________ relative to their home currency.
A)appreciating;depreciating
B)depreciating;depreciating
C)appreciating;appreciating
D)depreciating;appreciating

Accepted Answer

A firm would prefer to receive cash flows in a currency that is appreciating relative to their own so that they can exchange it for more of their home currency. On the other hand, they would prefer to pay out in currencies that are depreciating relative to their home currency so they can exchange their home currency for more of the foreign currency to pay for goods or services.

Question 12

Given a current spot rate of 8.10 Norwegian krone per U.S.dollar,expected inflation rates of 3% in Norway and 6% per annum in the U.S. ,use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.
A)7.87 krone per dollar
B)8.10 krone per dollar
C)8.34 krone per dollar
D)There is not enough information to answer this question.

Accepted Answer

Relative Purchasing Power Parity (RPPP) formula:
Expected change in spot rate = [(1 + expected inflation rate in domestic country)/(1 + expected inflation rate in foreign country)] - 1

Plug in the given values:
Expected change in spot rate = [(1+0.03)/(1+0.06)]-1 = -0.028

Expected spot rate after one year = Current spot rate x (1+expected change in spot rate) = 8.10 x (1 - 0.028) = 7.87 krone per dollar

Question 13

If a firm undertakes a project with ordinary cash flows and estimates that the firm has a positive NPV,then the IRR will be:
A)less than the cost of capital.
B)greater than the cost of capital.
C)greater than the cost of the project.
D)cannot be determined from this information

Accepted Answer

If the firm estimates a positive NPV, it means that the present value of the expected cash inflows is greater than the present value of the cash outflows, including the cost of capital. Therefore, the IRR must be greater than the cost of capital in order to generate a positive NPV.

Question 14

Instruction 18.1:
Use the information to answer the following question(s).
The Velo Rapid Revolutions Inc. ,a company that produces bicycles,elliptical trainers,scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe.The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed,but rather,must be depreciated over the life of the asset).Because this would be a new product,they will not be replacing existing equipment.The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years,however;expenses will also increase by euro 200,000 per year.(Note: Assume the after-tax operating cash flows in years 1-5 are equal,and that the terminal value of the project in year 5 may change total after-tax cash flows for that year. )The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000.The firm's required rate of return is 12% and they are in the 40% tax bracket.Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment,and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years).The current spot rate is $0.95/euro ,and the expected inflation rate in the U.S.is 4% per year and 3% per year in Europe.
-Refer to Instruction 18.1.What is the IRR of the Velo Rapid Revolutions expansion?
A)14.4%
B)10.3%
C)12.0%
D)8.6%

Accepted Answer

The answer of Instruction 18.1:
Use the information to answer the...

Question 15

When estimating a capital budget,it is common to separate cash flows into: 
1) the initial investment
2) incremental cash flows over the life of the project
3) a terminal value.

Accepted Answer

This is a common approach when estimating the capital budget for a project. The initial investment includes all costs incurred at the start of the project, while incremental cash flows are the additional cash flows generated by the project over its lifetime. The terminal value is the expected resale value of the project or its assets at the end of its useful life.

Question 16

Instruction 18.1:
Use the information to answer the following question(s).
The Velo Rapid Revolutions Inc. ,a company that produces bicycles,elliptical trainers,scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe.The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed,but rather,must be depreciated over the life of the asset).Because this would be a new product,they will not be replacing existing equipment.The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years,however;expenses will also increase by euro 200,000 per year.(Note: Assume the after-tax operating cash flows in years 1-5 are equal,and that the terminal value of the project in year 5 may change total after-tax cash flows for that year. )The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000.The firm's required rate of return is 12% and they are in the 40% tax bracket.Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment,and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years).The current spot rate is $0.95/euro ,and the expected inflation rate in the U.S.is 4% per year and 3% per year in Europe.
-Refer to Instruction 18.1.In euros,what is the NPV of the Velo Rapid Revolutions expansion?
A)€1,524,690
B)$1,611,317
C)-€75,310
D)-€111,317

Accepted Answer

To calculate the NPV, we need to find the present value of all the expected cash flows. 
1. Initial investment: -€1,400,000
2. Annual cash flow for 5 years: 
Revenues: €600,000
Expenses: -€200,000
Depreciation: (-€1,500,000 / 5) = -€300,000
Taxable income: €100,000
Taxes (40%): -€40,000
Net cash flow: €460,000
Present value of annual cash flow: 
Year 1: €424,242.42
Year 2: €366,493.76
Year 3: €316,868.53
Year 4: €274,063.23
Year 5: €236,231.43 (includes terminal value of equipment)
3. Recovery of NWC: €100,000 (received in year 5)
To calculate the present value of these cash flows, we need to discount them at the required rate of return, which is 12%. We also need to convert the cash flows from euros to dollars using the current spot rate of $0.95/euro and adjust for inflation in both regions. 
PV of initial investment: -€1,400,000 x $0.95 x (1 + 0.04) = -$1,483,600
PV of annual cash flow: 
Year 1: €424,242.42 x $0.95 x (1 + 0.04) / (1 + 0.12) = $457,577.58
Year 2: €366,493.76 x $0.95^2 x (1 + 0.04)^2 / (1 + 0.12)^2 = $345,679.35
Year 3: €316,868.53 x $0.95^3 x (1 + 0.04)^3 / (1 + 0.12)^3 = $314,082.90
Year 4: €274,063.23 x $0.95^4 x (1 + 0.04)^4 / (1 + 0.12)^4 = $288,480.90
Year 5: €236,231.43 x $0.95^5 x (1 + 0.04)^5 / (1 + 0.12)^5 = $267,022.95
PV of recovery of NWC: €100,000 x $0.95^5 x (1 + 0.04)^5 / (1 + 0.12)^5 = $98,892.22
NPV = sum of PV of all cash flows = -$1,483,600 + $457,577.58 + $345,679.35 + $314,082.90 + $288,480.90 + $267,022.95 + $98,892.22 = -€75,310. Therefore, the correct answer is (C).

Question 17

When evaluating capital budgeting projects,which of the following would NOT necessarily be an indicator of an acceptable project?
A)an NPV > $0
B)an IRR > the project's required rate of return
C)an IRR > $0
D)All of the above are correct indicators.

Accepted Answer

An IRR greater than zero indicates that the project would generate a return greater than the opportunity cost of capital, but it does not necessarily mean that the project is acceptable. Projects should generate returns greater than the required rate of return, and have a positive NPV to be considered acceptable. Therefore, option C does not guarantee that the project will create value for the company.

Question 18

When assessing the additional risk that can occur from investing abroad firms may choose to account for risk via:
A)adjusting the cash flows.
B)adjusting the discount rates.
C)adjusting both cash flows and discount rates.
D)adjusting all of the above.

Accepted Answer

Adjusting for risk when investing abroad can involve modifying the cash flows to reflect potential risks such as currency fluctuations or political instability, altering the discount rates to account for the additional risk of investing in a foreign market, or a combination of both. Therefore, all of the options provided are valid methods for accounting for additional risk.

Question 19

When dealing with international capital budgeting projects,the value of the project is NOT sensitive to the firm's cost of capital.

Accepted Answer

The value of an international capital budgeting project is sensitive to the firm's cost of capital. This is because the cost of capital is used as the discount rate to calculate the present value of future cash flows, which determines the project's net present value (NPV). A higher cost of capital will result in a lower NPV, while a lower cost of capital will result in a higher NPV. Therefore, it is important to consider the firm's cost of capital when evaluating international capital budgeting projects.

Question 20

Given a current spot rate of 8.10 Norwegian krone per U.S.dollar,expected inflation rates of 6% in Norway and 3% per annum in the U.S. ,use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.
A)7.87 krone per dollar
B)8.10 krone per dollar
C)8.34 krone per dollar
D)There is not enough information to answer this question.

Accepted Answer

The relative purchasing power parity (PPP) formula is S1 = S0 * (1 + i_foreign) / (1 + i_domestic), where S1 is the future spot rate, S0 is the current spot rate, i_foreign is the inflation rate in the foreign country, and i_domestic is the inflation rate in the domestic country. Plugging in the given values: S1 = 8.10 * (1 + 0.06) / (1 + 0.03) = 8.10 * 1.06 / 1.03 ≈ 8.34 krone per dollar.

Quiz 18: Multinational Capital Budgeting and Cross-Border Acquisitions

When estimating a firm's cost of equity capital using the CAPM,you need to estimate:

When determining a firm's weighted average cost of capital (WACC) which of the following terms is NOT necessary?

A criticism of adjusting the discount rate to account for political risk is that adjusting the discount rate for political risk penalizes early cash flows too heavily while not penalizing distant cash flows enough.

When determining a firm's weighted average cost of capital (wacc) which of the following terms is NOT necessary?

When a multinational firm invests abroad,it is common to develop two capital budgets: one from the project viewpoint,and one from the parent viewpoint.

________ is the risk that a foreign government will place restrictions such as limiting the amount of funds that can be remitted to the parent firm,or even expropriation of cash flows earned in that country.

Because international capital budgeting is so difficult,time consuming,expensive,and uncertain,firms generally forego any type of additional sensitivity analysis after completing a base-case scenario.

Generally speaking,a firm wants to receive cash flows from a currency that is relative to their own,and pay out in currencies that are relative to their home currency.

Given a current spot rate of 8.10 Norwegian krone per U.S.dollar,expected inflation rates of 3% in Norway and 6% per annum in the U.S. ,use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.

If a firm undertakes a project with ordinary cash flows and estimates that the firm has a positive NPV,then the IRR will be:

When estimating a capital budget,it is common to separate cash flows into: 1) the initial investment 2) incremental cash flows over the life of the project 3) a terminal value.

When evaluating capital budgeting projects,which of the following would NOT necessarily be an indicator of an acceptable project?

When assessing the additional risk that can occur from investing abroad firms may choose to account for risk via:

When dealing with international capital budgeting projects,the value of the project is NOT sensitive to the firm's cost of capital.

Given a current spot rate of 8.10 Norwegian krone per U.S.dollar,expected inflation rates of 6% in Norway and 3% per annum in the U.S. ,use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.