The Wheel Deal Inc., a company that produces 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 €1,200,000 and additional installation of €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 firm’s revenues by €600,000 per year over current levels for the next 5 years, however; expenses will also increase by €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 €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 €0 over the 5-year life of the equipment, and the investment also requires an increase in NWC of €100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/€, and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.
a) What are the annual after-tax cash flows for the Wheel Deal project?
b) In euro, what is the NPV of the Wheel Deal expansion?
c) What is the IRR of the Wheel Deal expansion?
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