Room & Broom Plc is a UK incorporated company with its head office in Milton Keynes. The company is considering establishing a new project in the country of Kwagali. Room & Broom is expecting the project to last four years. A new high technology cleaning machine will be produced for the industrial cleaning in Kwagali.

This project will cost Room & Broom Kwagalian K2,500,000. The cost will be represented by plant and equipment of K2,000,000 and working capital of K500,000. Working capital will increase by K50,000 every year. At the end of the project the working capital will be recovered. At the end of the project the plant and equipment will be valued at K900,000.

Room & Broom management have estimated annual sales of K2,200,000 and cash expenditure is estimated to be K1,000,000 per annum as at time 0. The sales and costs are expected to rise at a rate of 3% and 2% per annum respectively.

Tax is payable at a rate of 30% in Kwagali and payable one year in arrears. Tax allowable depreciation is at a rate of 25% on a straight-line basis for plant and equipment. UK tax rate on taxable profits is 20%, payable one year in arrears. The company’s policy is to remit the maximum funds possible to the UK parent company at the end of each year. No additional tax is payable on profits remitted to the UK. Administration costs of £150,000 per annum will be incurred in the UK over the project lifetime.

The exchange rate at time 0 is £1 = K4. The K currency is expected to appreciate against the £ by 2% per year. The company’s cost of capital on the project is 10%.

YOU ARE REQUIRED TO:

1. Estimate the net present value of the project in pound sterling (£) by converting project cashflows into pound sterling and discount at pound sterling discount rate.
2. Explain the benefits of NPV and advise whether the project should be undertaken. (suggested word count 100 words)
3. Discuss the exposure to foreign exchange risk faced by companies investing internationally.