A US company is considering building a UK plant. What is the adjusted present value (APV)?

Step1. Calculate Present Value of After Tax Cash Flow

Step2. Present Value of Depreciation Tax Shields

Step3. PV of Concessionary Loan Payment

Step4. Benefit from concessionary loan

Step5. Interest tax shields

Step6. Calculate APV

Blow are the information provided:

1. Initial capital outlay: GBP 20 million on plant and machinery.

2. The plant will produce 60,000 items in year 1, and production will increase at 10% a year up to and including year 4. This is incremental sales.

3. The current price of the product is GBP 250 per item and this is expected to increase in line with inflation.

4. The current variable cost of production is GBP 140 per item and, again, this is expected to increase in line with inflation. Of this, GBP 30 per product is sourced from the Home company in America. A profit margin of 25% is made on these sales.

5. The expected inflation rate in the US and UK respectively are 3% and 5%.

6. The corporation tax rate is 40% in the UK and 35% in the US.

7. The project is assumed to have a beta of 1 and the real rate of interest is assumed to be approximately 1 % in both the US and the UK. A market risk premium of 8% can be applied.

8. Plant and machinery in the UK is assumed to be written down on a straight-line basis over 4 years with no residual value.

9. The current spot rate is USD/GBP =2.00.

10. If the real interest rate is 1%, then the risk-free rate is approximately 6%, and the cost of capital 14% in the UK