An MNC is considering establishing a two-year project in New Zealand with a $30 million initial investment. The firm's cost of capital is 12 percent. The required rate of return on this project is 18 percent. The project is expected to generate cash flows of NZ$12 million in Year 1 and NZ$30 million in Year 2, excluding the salvage value. Assume no taxes and a stable exchange rate of $.60 per NZ$ over the next two years. All cash flows are remitted to the parent. What is the break-even salvage value?
A) about NZ$11 million
B) about NZ$15 million
C) about NZ$31 million
D) about NZ$37 million
E) about NZ$25 million

Question

Quizplus · Accepted Answer

The break-even salvage value is the amount that makes the net present value (NPV) of the project equal to zero, given the project's cash flows and the required rate of return. To find this, we first calculate the present value (PV) of the cash flows, then solve for the salvage value that makes the NPV equal to zero.1. Convert NZ$ cash flows to US$ at the exchange rate of $.60/NZ$:   - Year 1: NZ$12 million * $.60 = $7.2 million   - Year 2: NZ$30 million * $.60 = $18 million2. Calculate the present value of these cash flows using the required rate of return of 18%:   - PV of Year 1 cash flow: $7.2 million / (1 + 0.18)^1 = $6.1 million (approximately)   - PV of Year 2 cash flow: $18 million / (1 + 0.18)^2 = $12.9 million (approximately)3. The total PV of cash flows without the salvage value is $6.1 million + $12.9 million = $19 million.4. To break even, the total PV of the project (including the salvage value) must equal the initial investment of $30 million. Thus, the PV of the salvage value must make up the difference:   - Required PV of salvage value = $30 million - $19 million = $11 million5. Solve for the nominal value of the salvage value in Year 2 that has a PV of $11 million:   - Salvage value in Year 2 = $11 million * (1 + 0.18)^2 = $11 million * 1.3924 = $15.316 million (approximately)6. Convert this back to NZ$ at the exchange rate of $.60/NZ$:   - Salvage value in NZ$ = $15.316 million / $.60 = NZ$25.526 million (approximately)Therefore, the break-even salvage value is about NZ$25 million.

An MNC Is Considering Establishing a Two-Year Project in New