MSDI
Alcala de Henares, Spain
Click to edit Master subtitle style
Now
Future
U.S. Dollar
NPV
Cash
Flows
Spanish Peseta
Cash Flows
Forecast foreign currency free cash flows
Incorporate expected foreign currency inflation
Use appropriate effective tax rate: generally the
higher of the foreign or domestic tax rates
Include the terminal value: the market value of
disposal or the value of the perpetual cash flows
Discount
Method A: Discount at foreign WACC and
convert at spot rate
Method B: Convert at expected spot rates
and discount at domestic WACC
Method A
Now
Future
U.S. Dollar
NPV
Cash
Flows
Spanish Peseta
Method B
Now
Future
U.S. Dollar
NPV
Cash
Flows
Spanish Peseta
Recommend Method B
Companies should know their domestic WACC
but may not know the foreign WACC
Methods for forecasting spot rates are the same as
converting a domestic WACC to a foreign WACC
(forward parity, international Fisher effect,
purchasing power parity)
Method B makes it much clearer what your
assumptions are (in the form of expected spot
rates) than Method A (in the form of a foreign
Cash Flows
Installed cost of new machinery
Disposal of old machinery: net of market
value and tax effect of disposal
After tax operating cost savings
Tax effects of loss of old machinery
depreciation and gain of new machinery
depreciation
No terminal cash flows
Installed Cost of New Machinery
61,525,000 ESP
Disposal of Old Machinery
950,000 ESP Market Value
1,605,000 ESP Book Value
655,000 ESP (1,605,000-950,000) Loss on
Sale
229,250 ESP (655,000 x .35) Tax Benefit of
Sale
1,179,250 ESP (950,000+229,250) Net
Effect of Sale of Old Machinery
After Tax Operating Cost
Savings
Year
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Old Cost
88,496
88,662
93,686
97,634
101,091
104,872
109,101
113,765
119,012
124,872
New Cost
69,676
69,808
73,763
76,872
79,594
82,571
85,901
89,573
93,704
98,318
Cost Saving
18,820
18,854
19,923
20,762
21,497
22,301
23,200
24,192
25,308
26,554
After Tax
12,233
12,255
12,950
13,495
13,973
14,496
15,080
15,725
16,450
17,260
Loss of Old Machinery
Depreciation
1,605,000 ESP Book Value
3 Years Remaining Straight Line
Depreciation
535,000 ESP (1,605,000/3) Depreciation
per Year
187,250 ESP (535,000 x .35) Depreciation
Tax Savings per Year
Gain of New Machinery
Depreciation
61,525,000 ESP Book Value
10 Years Remaining Straight Line
Depreciation
6,152,500 ESP (61,525,000/10)
Depreciation per Year
2,153,375 ESP 6,152,500 x .35)
Depreciation Tax Savings per Year
Net Cash Flows
Year
0
1 (1988)
2 (1989)
3 (1990)
4 (1991)
5 (1992)
6 (1993)
7 (1994)
8 (1995)
9 (1996)
10 (1997)
Installed Cost
of New Machinery
(61,525,000)
Disposal
of Old Machinery
Net Operating
Cost Savings
Old Machine
Depreciation
New Machine
Depreciation
1,179,250
12,233,000
12,255,100
12,949,950
13,495,300
13,973,050
14,495,650
15,080,000
15,724,800
16,450,200
17,260,100
(187,250)
(187,250)
(187,250)
2,153,375
2,153,375
2,153,375
2,153,375
2,153,375
2,153,375
2,153,375
2,153,375
2,153,375
2,153,375
Net
Cash Flows
(60,345,750)
14,199,125
14,221,225
14,916,075
15,648,675
16,126,425
16,649,025
17,233,375
17,878,175
18,603,575
19,413,475
Forward Rates
(Forward Parity)
Spot Rate: 127.00 ESP/USD
1-Month Forward Rate: 125.85 ESP/USD
3-Month Forward Rate: 123.70 ESP/USD
Expected Spot Rate Factor = .8961
((((123.70-127.00)/127.00) x 4) + 1)
Interest Rates
(International Fisher Effect)
Spanish Rates (Case): Short-Term Loans 18%;
Long-Term Loans 15%
Spanish Rates (Exhibit 3): Daily Interbank Rate
18.1%; 6-12 Month Deposit Rate 8.8%; ShortTerm Commercial Loans 17.9%
U.S. Rates (Case): Prime Loan Rate 8.5%
U.S. Rates (Exhibit 4): 3 Month T-Bills 5.73%; 10
Year T-Bonds 8.34%; 6 Month Commercial Paper
6.85; Prime Commercial Rate 8.5%
Expected Spot Rate Factor = 1.0599 (1.15/1.085)
Inflation Rates
(Purchasing Power Parity)
Spanish CPI: 8.8%
U.S. CPI: 1.9%
Expected Spanish Inflation: 8%?
Expected U.S. Inflation: 4%?
Expected Spot Rate Factor (Historical
Inflation) = 1.0677 (1.088/1.019)
Expected Spot Rate Factor (Expected
Inflation) = 1.0385 (1.08/1.04)
Other Information
Economists 5-Year Forecasts: 80-170
ESP/USD
Spanish Real GDP Growth: 3.3%
U.S. Real GDP Growth: 2.9%
Expected Spot Rates
Year
Forward Rates
Interest Rates
Historical
Inflation Rates
Expected
Inflation Rates
Factor
0.8961
1.0599
1.0677
1.0385
0
1 (1988)
2 (1989)
3 (1990)
4 (1991)
5 (1992)
6 (1993)
7 (1994)
8 (1995)
9 (1996)
10 (1997)
127.00
113.80
101.98
91.38
81.89
73.38
65.76
58.92
52.80
47.32
42.40
127.00
134.61
142.67
151.22
160.27
169.87
180.05
190.83
202.27
214.38
227.22
127.00
135.60
144.78
154.58
165.04
176.22
188.15
200.89
214.49
229.01
244.51
127.00
131.89
136.97
142.24
147.72
153.40
159.31
165.44
171.81
178.43
185.30
Net
Cash Flows
(60,345,750)
14,199,125
14,221,225
14,916,075
15,648,675
16,126,425
16,649,025
17,233,375
17,878,175
18,603,575
19,413,475
USD Cash Flows
Year
0
1 (1988)
2 (1989)
3 (1990)
4 (1991)
5 (1992)
6 (1993)
7 (1994)
8 (1995)
9 (1996)
10 (1997)
Expected
Inflation Rates
127.00
131.89
136.97
142.24
147.72
153.40
159.31
165.44
171.81
178.43
185.30
Net
Cash Flows
(60,345,750)
14,199,125
14,221,225
14,916,075
15,648,675
16,126,425
16,649,025
17,233,375
17,878,175
18,603,575
19,413,475
USD
Cash Flows
(475,163.39)
107,659.25
103,829.39
104,865.19
105,937.04
105,124.00
104,507.17
104,164.83
104,056.08
104,263.95
104,769.42
NPV = 95,317.59 USD
Click to edit Master subtitle style
Method A: ESP Discount Rate
Forward Parity Discount Rate: 1.26% ((1.13 x .
8961)-1)
International Fisher Effect Discount Rate: 19.77%
((1.13 x 1.0599)-1)
Purchasing Power Parity Discount Rate (Historical
Inflation): 20.65% ((1.13 x 1.0677)-1)
Purchasing Power Parity Discount Rate (Expected
Inflation): 17.35% ((1.13 x 1.0385)-1)
Method A: ESP NPV
Year
0
1 (1988)
2 (1989)
3 (1990)
4 (1991)
5 (1992)
6 (1993)
7 (1994)
8 (1995)
9 (1996)
10 (1997)
Discount Rate
Net
Cash Flows
(60,345,750)
14,199,125
14,221,225
14,916,075
15,648,675
16,126,425
16,649,025
17,233,375
17,878,175
18,603,575
19,413,475
0.1735
NPV (ESP)
12,105,333.82
NPV (USD)
95,317.59
Comparative NPVs
Theory
Forward Rates
Interest Rates
Historical
Inflation Rates
Expected
Inflation Rates
NPV (ESP)
93,105,320.84
5,857,833.46
3,795,147.91
12,105,333.82
NPV (USD)
733,112.76
46,124.67
29,883.05
95,317.59
