Paprika International Inc. is a multinational company, headquartered in India, that manufactures metal parts used in the production of kayaks and canoes in Australia. Paprika is increasingly concerned about climate change and wants to reduce its carbon footprint. It is considering replacing an old machine for an environmentally friendly one. The new machine will cost $370,000 and will require additional installation and shipping costs of $25,000 each. The new machine will be depreciated with the straight-line method over a 7-year useful life. The old machine was purchased 5 years ago at a cost of $180,000, originally had a useful life of 12 years (depreciated straight-line method). The old machine could be sold today for scrap value of $120,000. Due to the recent interest rate increase by the Reserve Bank of Australia, financing costs have increased, with the firm now requiring a one-off increase in net working capital equal to 10% of the total purchase price of the new machine (excluding shipping and installation costs), at the beginning of the investment. The working capital will be recovered upon the completion of project at the end of Year 7. Paprika Inc. estimates that the new machine would generate an increase in revenues of $60,500 each year. The corporate taxes are 30% and the firm has a required rate of return of 12.5%. The figures are denominated in AUD.

Required:

a. What is the projects total Free Cash Flow in year 0? Explain. [2 marks]

b. What is the projects total Free Cash Flow every year from Year 1 to Year 6? Explain. [3 marks]

c. What is the projects total Free Cash Flow in year 7? Explain. [1 mark]

d. Should Paprika replace the old machine with the new machine? Explain your answer in full. [1 mark]

e. Paprika International Inc. is exposed to foreign exchange risk as it will need to repatriate the cash flows to the parent company in India. How can Paprika hedge this risk? Explain in full. Does hedging necessarily make Paprika better off? [1 mark]