Divestiture Decision
Response to the following problem:
Kylee Co. (a U.S. firm) has a British subsidiary that will generate cash flows of 3 million pounds at the end of each of the next two years. It uses the prevailing spot rate of the British pound of $1.80 as a forecast of the future value of the pound. Its required rate of return on this business is 16 percent. Kylle just received an offer from a British company who wants to buy the subsidiary for $8,000,000. Assume that Kylle would not be subject to any tax on the sale.
a. Should Kylle Co. sell the business? Show your work.
b. Assume that there is news today that causes Kylle to think that the British pound will strengthen substantially the next two years. Assume the offer price remains unchanged. If Kylle reassesses whether to divest based on this information, do you think the potential news will increase the net present value of the divestiture (make the divestiture more beneficial for Kylle), reduce the net present value of the divestiture, or have no impact on the estimated net present value .
c. Assume that today the prevailing long-term U.S. risk-free interest rate decreased and that this has no effect on Kylle's cash flows from operations. Assume the offer price remains unchanged. Do you think this information about the decline in the U.S. risk-free interest rate will increase the net present value of the divestiture, reduce the net present value of the divestiture, or have no impact on the estimated net present value of the divestiture? Briefly explain.