Case 2 Geo Tech Cash Flow Template (Base Case)
Year				0	1	2	3	4	5
					$600,000.00	$1,080,000.00	$1,050,000.00	$750,000.00	$570,000.00
Revenues
Cash Costs
Set up					$280,000.00	$420,000.00	$280,000.00	$140,000.00	$140,000.00
Other operating					$240,000.00	$240,000.00	$360,000.00	$360,000.00	$240,000.00
Depreciation					$280,000.00	$280,000.00	$280,000.00
EBIT					-$200,000.00	$140,000.00	$130,000.00	$250,000.00	$190,000.00
Taxes					-$70,000.00	$49,000.00	$45,500.00	$87,500.00	$66,500.00
Net Operating Income After Taxes					-$130,000.00	$91,000.00	$84,500.00	$162,500.00	$123,500.00
Add Depreciation					$280,000.00	$280,000.00	$280,000.00
Net Operating Cash Flows					$150,000.00	$371,000.00	$364,500.00	$162,500.00	$123,500.00
Recovery of Capital Assets (AT)									$65,000.00
Project Cost				-$840,000.00
Total Cash Flow (CAD)				-$840,000.00	$150,000.00	$371,000.00	$364,500.00	$162,500.00	$188,500.00
Exchange Rate				0.860	0.860	0.860	0.860	0.860	0.860
Total Cash Flow (USD)				-$722,400.000	$129,000.000	$319,060.000	$313,470.000	$139,750.000	$162,110.000

Make adjustments for foreign exchange forecast of the Canadian dollar/U.S. dollar exchange rate, below

FX Forecast
Project Year	0	1	2	3	4	5
Calendar Year	2014	2015	2016	2017	2018	2019
FX Rate	0.860	0.825	0.805	0.790	0.780	0.775

adjust for inflation, Inflation in the United States was quite low and expected to average about 1.50% over the next five years. Inflation in Canada was expected to be slightly higher at 1.75%. Please use excel to answer.

Thanks.

edit:

Guidelines and Suggestions for Case 2, Geo Tech

Geo Tech provides the opportunity to analyze and consider a capital investment project in an international context (multinational capital budgeting). Specifically, a US business is considering the establishment of a presence in Alberta, Canada. The Geo Tech case requires the application of capital budgeting techniques with the added complexity of adjusting for and managing exchange rate risk.

Capital Budgeting Considerations. The narrative provides a wealth of detail allowing for the important determination of relevant cash flows. Typically, relevant cash flows in a capital budgeting context are classified as initial investment, additional investment during the life of the project, project cash flows, and terminal cash flows. A summary of the pertinent cash flows is presented on Pp. 2-3 of the case narrative.

Initial Investment. Geo Tech will make an initial investment in equipment. Presume this investment is made in Year 0. This equipment outlay is the only initial investment mentioned in the case.

Additional Investment. Additional investment that might be included in a project include renovation of plant and equipment and investment in net working capital to support the sales forthcoming from the project. These investments are not expenses to be charged against revenue, so have no tax consequences when made. Like initial investment, there may be recoveries at the end of the project. The case makes no mention of additional investment outflows, so these types of flows may be ignored.

Project Cash Flows. The classic model for yearly project cash flows is EBIT(1 Tx) + Depreciation (this case describes a proposed investment by a US company, and US terminology favors the word depreciation in place of the word amortization). The case describes number of new clients per year, initial set up fees per client, annual license fees, and length of contract. The case describes costs as set up costs and other cash operating costs. Depreciation charges are described as straight line over three years and tax rate is suggested.

As important as the descriptions of the revenue and cost structures are, of equal importance is what is not described. First, Canada has a complicated process for determining allowable amortization that includes capital cost allowance, asset classification, asset pools, and investment tax credits. The case says nothing about depreciation (amortization) under Canadian tax rules, so you should ignore these complexities and go with the simple straight line depreciation as described. Second, multinational operations typically are subject to complex tax arrangements and may involve restrictions or taxes on profit transfers to the home country, and the home country may provide for foreign tax credits as an offset against domestic taxation. Again, the case is silent about these considerations, so ignore these taxation complexities and assume the tax rate suggested is a net tax rate.

Terminal Cash Flows. In principal, terminal cash flows can be either outflows or inflows. Examples of outflows include any mandated clean up or restoration expenses. Examples of terminal inflows would be sale of plant and equipment if there is any economic value remaining, and recovery of net working capital. The sale of plant and equipment must consider taxes. Taxes are computed on the difference between market value and book value. If MV > BV, that difference is taxable at ordinary rates and reduces the cash inflow from the sale. If MV = BV, there is no tax on the sale. If MV < BV, that difference represents a tax credit and increases the effective cash inflow from the sale. The recovery of NWC is not a taxable event, but any remaining build-up of NWC during the life of the project is released at the end of the project, and represents a cash inflow in the final year of the project. In the Case there is no mention of working capital investment, so there will be no recovery of this item.

Timing of Cash Flows. The case states that set up fees are paid at contract signing and annual licensing fees are paid a few months later for the first year and on the anniversary thereafter. A similar treatment for payment of costs is described. However, due to uncertainty about when clients would be signed, as well as to reduce complexity of analysis, Geo Tech will simplify timing by assuming all project cash flows will arrive at the end of the year.

Weighted Average Cost of Capital. The narrative describes an appropriate cost of capital to be used for determining Net Present Value and evaluating the potential project. While risk is usually higher with foreign ventures, apparently Geo Tech is convinced that in this instance the project flows have comparable risk to its domestic projects. No further risk adjustment is necessary or required.

Exchange Rate Considerations. An added source of adventure in any multinational setting is the foreign currency or exchange rate problem. Geo Tech is a US company that will pay out US dollars (USD) and will receive Canadian dollars (CAD). Since the proposed project is located in Canada, the expenditure side involves converting USD to CAD, and the revenue side involves converting CAD to USD.

Cash Flows. The initial exchange rate is provided in the narrative. It is convenient to set up notation for an exchange rate as S_USD/CAD, where S is the spot exchange rate in terms of USD for CAD, in other words, the USD price of the CAD (how much US must be paid for a Canadian dollar). This is really the only exchange rate information required, because the Canadian price of the USD is related to the US price of the CAD as follows: S_CAD/USD = 1/ S_USD/CAD.

You must be very careful about translating the cash flows appropriately. For example, the narrative quotes the annual Foresight license at 8,000 USD, equivalent to 9,302 CAD at the current exchange rate of 0.86 USD per CAD (8000 x 1/0.86 = 9302 or simply 8000/0.86 = 9302). The Case states that this CAD fee is rounded to the nearest $1,000, for a fee of 9,000 CAD. Set-up fees in CAD are determined in the same manner.

Ultimately, Geo Tech will be making an investment decision based on NPV in USD terms. The project cost at Year 0 is estimated at 840,000 CAD. You should determine the USD equivalent. When you determine the annual project cash flows, the last step is to convert the net cash flows into USD.

Exchange Rate Risk and Estimation. Exchange rates do not stay constant, indeed they change constantly. So it is necessary to forecast exchange rates over the life of the project, and this introduces additional risk. Information is provided regarding an exchange rate forecast and projected inflation. Inflation rates and exchange rates are (imperfectly) related through a concept know as Purchasing Power Parity (PPP). PPP says that similar commodities in two countries should be priced the same after allowing for exchange rates. That is, P_CAD = P_USD(S_CAD/USD). This means that if a Canadian national crosses the border and buys a box of cherries, the individual must first buy USD, and then buy the cherries, furthermore the US price and the exchange rate should be such that the buying on either side is equivalent. Rearranging gives S_CAD/USD = P_CAD/P_USD, that is, the Canadian price of the US dollar is equal to the ratio of Canadian prices to US prices. If inflation is higher in the US than it is in Canada, the CAD will appreciate (the USD will cost less), but if inflation is higher in Canada, the CAD will depreciate (the USD will cost more).

Obviously, other factors besides inflation are involved in exchange rate determination. The narrative does not bring other considerations into play, and there is no need to gather additional information (and do not look up rates that prevailed during the time period and apply them to your estimated cash flows). However, you are encouraged to investigate the exchange rate forecasts that are provided and to see how well the PPP idea explains the forecast. If the forecast does not fit PPP well, you may want to discuss the matter.

When you do convert the Canadian-denominated cash flows into USD, your next step is to apply capital budgeting techniques. This analysis should include NPV. It is up to you to determine if additional analytics such as Internal Rate of Return or Payback provide additional useful information in forming an accept/reject recommendation.

Additional Considerations. The narrative clearly states that Geo Tech management is interested in the sensitivity of the numbers to the assumptions made. There are several ways to enrich the analysis with these approaches to risk management. For example, you might explore what happens to NPV if the exchange rate differs from forecast levels by some percentage steps. You can do this type of sensitivity analysis to a variety of variables if you wish. What if analysis is a close relative to sensitivity analysis. Simulations are a possibility, but probably beyond the scope of the course content and are not expected.

There are a variety of exchange risk strategies and tools that might be considered, but again, many of these are beyond the scope of our coverage in this course. Money market hedges are not a good idea because they are put in play for short-term exposure, not exposure over five years. Currency futures, forwards, or options could be implemented, although each of these would have to be rolled over during the life of the project.

Finally, there is always the matter of nonfinancial considerations. Does the project make sense from a marketing perspective, will it open doors to future opportunities, does it make sense from an organizational and strategic fit perspective?

Base Case

Please begin your analysis with a base case. Use the initial assumptions as given, including a five-year horizon, no inflation, with exchange rates constant at the beginning level of 0.86 USD/CAD over the life of the project. You may then examine and compare alternative scenarios by incorporating changes into your analysis as you deem appropriate.