XYZ Company from Australia is considering investing domestically for a project with pure equity financing and the hurdle rate is 6% p.a., even though it can issue a three-year par-valued bond traded on ASX with coupon rate 5% p.a.. At this time, XYZ receives a proposal from its British subsidiary ABC to build a new plant in the United Kingdom. It has the same risk as the project XYZ is considering and the cash flow generated are as follows: The current spot rate is 1.80A$/. The firm's tax rate is 25% in Australia and 19% in UK. XYZ will shoulder all the financial risk of ABC. ABC managed to obtain a three-year loan of 200k from British government at a coupon rate of 4.5% p.a. 2a) ABC forecasts that over the next three years, the expected inflation for UK and Australia are 5% p.a. and 2% p.a. respectively and it believes PPP holds. Would ABC recommend going ahead with the project or not based on this information? Show the detailed calculation to justify the recommendation. (10 marks) 2b) Separately, the board of XYZ, is worried about the consequences of uncertainty associated with the Brexit. It seeks the consultation of Professor Markt. Prof. Markt points out that over the next three years, the British economy is going to be worse, and the forecasted spot rates will be 1.7000 $/,1.6900$/,1.6400$/ respectively according to his estimation. Would the board recommend taking on the project or not based on this information? Show the detailed calculation to back up the recommendation. (3 marks) 2c) The board looks at the two recommendations and wants to make sense of two results. Discuss the reasons why they are the same or different. (2 marks) XYZ Company from Australia is considering investing domestically for a project with pure equity financing and the hurdle rate is 6% p.a., even though it can issue a three-year par-valued bond traded on ASX with coupon rate 5% p.a.. At this time, XYZ receives a proposal from its British subsidiary ABC to build a new plant in the United Kingdom. It has the same risk as the project XYZ is considering and the cash flow generated are as follows: The current spot rate is 1.80A$/. The firm's tax rate is 25% in Australia and 19% in UK. XYZ will shoulder all the financial risk of ABC. ABC managed to obtain a three-year loan of 200k from British government at a coupon rate of 4.5% p.a. 2a) ABC forecasts that over the next three years, the expected inflation for UK and Australia are 5% p.a. and 2% p.a. respectively and it believes PPP holds. Would ABC recommend going ahead with the project or not based on this information? Show the detailed calculation to justify the recommendation. (10 marks) 2b) Separately, the board of XYZ, is worried about the consequences of uncertainty associated with the Brexit. It seeks the consultation of Professor Markt. Prof. Markt points out that over the next three years, the British economy is going to be worse, and the forecasted spot rates will be 1.7000 $/,1.6900$/,1.6400$/ respectively according to his estimation. Would the board recommend taking on the project or not based on this information? Show the detailed calculation to back up the recommendation. (3 marks) 2c) The board looks at the two recommendations and wants to make sense of two results. Discuss the reasons why they are the same or different. (2 marks)
