Week 1 Problems solution
22.
Project NPV Hindustan Motors has been producing its Ambassador car in India since 1948. As the company's website explains, the Ambassador's “dependability, spaciousness, and comfort factor have made it the most preferred car for generations of Indians.” Hindustan is now considering producing the car in China. This will involve an initial investment of RMB 4 billion.14 The plant will start production after one year. It is expected to last for five years and have a salvage value at the end of this period of RMB 500 million in real terms. The plant will produce 100,000 cars a year. The firm anticipates that in the first year it will be able to sell each car for RMB 65,000, and thereafter the price is expected to increase by 4% a year.
Raw materials for each car are forecasted to cost RMB 18,000 in the first year and these costs are predicted to increase by 3% annually. Total labor costs for the plant are expected to be RMB 1.1 billion in the first year and thereafter will increase by 7% a year. The land on which the plant is built can be rented for five years at a fixed cost of RMB 300 million a year payable at the beginning of each year. Hindustan's discount rate for this type of project is 12% (nominal). The expected rate of inflation is 5%. The plant can be depreciated straight-line over the five-year period and profits will be taxed at 25%. Assume all cash flows occur at the end of each year except where otherwise stated. What is the NPV of the project plant?
22. We can use the following spreadsheet to calculate a NPV of 6.352 billion RMB for the Ambassador China project. This calculation uses the following assumptions:
1. Calculations are done on a nominal basis, converting the salvage value estimate from a real to a nominal value (638 = 500(1.05)5) using the 5% inflation estimate; salvage = book value so no taxes are incurred on salvage.
2. Depreciation is calculated at [4,000 – 638 (salvage) ]/ 5 = 672.4 per year.
3. Cars sales occur in year 1
Project NPV Hindustan Motors has been producing its Ambassador car in India since 1948. As the company's website explains, the Ambassador's “dependability, spaciousness, and comfort factor have made it the most preferred car for generations of Indians.” Hindustan is now considering producing the car in China. This will involve an initial investment of RMB 4 billion.14 The plant will start production after one year. It is expected to last for five years and have a salvage value at the end of this period of RMB 500 million in real terms. The plant will produce 100,000 cars a year. The firm anticipates that in the first year it will be able to sell each car for RMB 65,000, and thereafter the price is expected to increase by 4% a year.
Raw materials for each car are forecasted to cost RMB 18,000 in the first year and these costs are predicted to increase by 3% annually. Total labor costs for the plant are expected to be RMB 1.1 billion in the first year and thereafter will increase by 7% a year. The land on which the plant is built can be rented for five years at a fixed cost of RMB 300 million a year payable at the beginning of each year. Hindustan's discount rate for this type of project is 12% (nominal). The expected rate of inflation is 5%. The plant can be depreciated straight-line over the five-year period and profits will be taxed at 25%. Assume all cash flows occur at the end of each year except where otherwise stated. What is the NPV of the project plant?
22. We can use the following spreadsheet to calculate a NPV of 6.352 billion RMB for the Ambassador China project. This calculation uses the following assumptions:
1. Calculations are done on a nominal basis, converting the salvage value estimate from a real to a nominal value (638 = 500(1.05)5) using the 5% inflation estimate; salvage = book value so no taxes are incurred on salvage.
2. Depreciation is calculated at [4,000 – 638 (salvage) ]/ 5 = 672.4 per year.
3. Cars sales occur in year 1