Advanced Financial Management: The Cross-border Valuation

Today is 27th April, 2016. You are a senior financial analyst with IBM in their capital budgeting division. IBM is considering expanding in Australia due to its positive business atmosphere and cultural similarities to the U.S.
The new facility would require aone-off initial investment in fixed assets of $5 billion in Australian andadditional capital investment of 3% of revenueeach year in year 1-4. All capital investments would be depreciated straight-line to zero over five years. Assume thatat the end of the project the sales price of equipment is zero and the tax effect is also zero. First-year revenues from the facility are expected to be $6 billion Australian and grow at 10% per year. The cost of goods sold (COGS) would be 40% of revenue; the other operating expenses would amount to 12% of revenue. Depreciation and amortisation expenses (D&A) are included in COGS and other operating expenses. Net working capital requirements would be 11% of sales and would be required the year prior to the actual revenues. All net working capital would be recovered at the end of the fifth year. Assume that the tax rates are the same in the two countries, and that two markets are internationally integrated, and that the cash flow uncertainty of the project is un-correlated with changes in the exchange rate (hint: you can use the home currency approach to value the Australian business; the home currency is USD). You manager wants you to find the NPV of the project in U.S. dollars using a USD cost of capital of 12%.
You have the following market data:
Spot exchange rate: AUD1.3174/USD or 1 USD= 1.3174 AUD (as of 27th April 2016, Bloomberg)
Yield-to-maturity (YTM) of zero-coupon government bonds (as of 27th April 2016, Bloomberg and estimates) (Hint: use these as interest rates to derive synthetic forward exchange rates)
(annual rates) 1-year 2-year 3-year 4-year 5-year
Australian yield-curve 1.73% 1.87% 1.96% 2.02% 2.06%
U.S. yield-curve 0.55% 0.78% 1.03% 1.16% 1.29%
Assume that IBM’s marginal corporate tax rate is 20%.

In your Excel spreadsheet, create a projection with timeline (from year 0 to 5). Project free cash flows from this project (without considering any financing effects) from year 0 to year 5 in Australian $ (million). Assume that amortisation is zero in all years and that all cash flows occur at the year end. Provide your projection as Appendix 2(1). You should use the template provided on Canvas (Worksheet“Q2” of FIN351_2016FC_Assignment2_Data.xlsx) (20 marks)
Compute synthetic forward rates for each of the five years of the project(F_(0,T)=〖(1+r)〗^T/〖(1+r^*)〗^T ×S_0). Then, use the forward rates to convert the cash flows to U.S. dollars. Provide your worksheet in Appendix 2(2). (15 marks)
Compute the NPV of the project in U.S. dollars using the 12% required return given by your manager. Include your DCF in Appendix 2(3). (5 marks)………………………………………..

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