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Alcala De Henares Caso Essay

623 words - 3 pages

Case 2: MSDI – Alcala de Henares, Spain

For all three questions, assume the followings:
- All international parity conditions hold (unless otherwise stated)
- Merck’s weighted average cost of capital is 15% for a similar U.S. project
- U.S. annual inflation rate is expected to be 5%

Question 1
Should Merck invest in the new photoelectric inspection equipment?

Question 2

Suppose the International Fisher Relation does not hold, i.e., the Spanish weighted average cost of capital is 25%.
Should Merck invest in the new photoelectric inspection equipment?

Q1.
Merk Sharp and Dohme International (MSDI) should invest in the new photoelectric inspection equipment in Madrid, Spain. They should make this investment, unless there is another that would offer a higher net present value, which might be true of the similar US project, considering cost of capitol is lower in the US by ...view middle of the document...

All of the advantages are nice to have, but with this operation the main issue was will it provide the company with a positive net present value, when the project is all said and done.
The issue of what currency to compute the discounted cash flows analysis currency is unnecessary since it would not matter in the final outcome of the NPV. Also the speculation that the peseta would appreciate over the coming years is a positive note, but considering the wide range and uncertainty of analysts it would not be a sufficient reason to pursue the project.
To decide if the project is satisfactory to do cash flows must be calculated. By selling the old equipment and purchasing the new equipment the company would be starting off with a net cash flow of -60345750 pesetas in year 0. Considering the depreciation and savings generated by the new equipment cash flows for the following years would be positive starting at 14386375 peseta in the first year and growing to 19413475 peseta by the 10th and final year. By entering the cash flows shown on the attatched spreadsheet for each year into a financial calculator and discounting at the weighted average cost of capitol for the project of 18.3%, found by using the international parity conditions, the net present value can be found. The NPV in peseta is 9948376, by using the spot rate given of USD 127/Pst the NPV in USD can be calculated and is 78334. Considering that the NPV is so overwhelmingly positive MSDI should pursue the project and implement the new inspection equipment in Madrid.

Q2
If the International Fisher Relation did not hold resulting in an increase of the Spanish weighted average cost of capital to 25%, MSDI would need to reconsider the proposal. Using all the same cash flows as previously, simply changing the discount rate to 25% reveals NPV is now negative. The new WACC causes the NPV to sink to -4628881 peseta or 36448 USD. Now that the NPV has become negative and so negative at that MSDI should no longer look to make the investment, and should examine the similar US project more closely.

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