You are the CFO of a Canadian firm that is considering building a $10 million factory in Russia to produce milk. The investment is expected to produce net cash flows of $3 million each year for the next 10 years, after which the investment will have to close down because of technological obsolescence. Scrap values will be zero. The cost of capital will be 6 percent if financing is arranged through the euro bond market. However, you have an option to finance the project by borrowing funds from a Russian bank at 12 percent. Analysts tell you that due to high inflation in Russia, the Russian ruble is expected to depreciate against the Canadian dollar. Analysts also rate the probability of violent revolution occurring in Russia within the next 10 years as high.
How would you incorporate these factors into your evaluation of the investment opportunity? What would you recommend the firm do?
NPV = C0 + Cn/ (1 + r)^n
C0 is the up-front cost
Cn = Cash flow each year
r = the periodic rate of return/ interest/ discount rate/ required rate of return
n = number of periods
Cost of Capital = 6%
NPV = C0 + Cn/(1 + r)n = -$10,000,000 + ($3,000,000/(1 + 0.06)10)10 = -$10,000,000 + ($1,675,184 x 10) = -$10,000,000 + ...
Financial management in the international business is examined.