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Published by imatache

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Categories:Types, Business/Law
Published by: imatache on Dec 01, 2010
Copyright:Attribution Non-commercial


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KH is a large food and drink retailer based in the United States of America. To date, the
company has operated only in the US but is planning to expand into South America by
acquiring a group of stores similar to those operated in the US. Projected cash flows in the
US and South America for the first three years of the project, in real terms, are estimated as

Year 0

Year 1

Year 2

Year 3

Cash flows in USA:
In US$’000

10,000 300 400


Cash flows in the South
American country:
In SA Currency’000

1,000,000 250,000 350,000 450,000

US$ cash flows are mainly incremental administration costs associated with the project. SA
currency cash flows are cash receipts from sales less all related cash costs and expenses.

The exchange rate for the South American country’s currency is extremely volatile. Inflation
is currently 40% a year. Inflation in the US is 4% a year. Best estimates by KH’s treasurer
suggest these rates are likely to continue for the foreseeable future. The current exchange
rate is SA currency 30 to US$1.

The following information is relevant:

• KH evaluates all investments using nominal cash flows and a nominal discount rate
• SA currency cash flows are converted into US$ and discounted at a risk-adjusted US rate
• All cash flows for this project will be discounted at 20%, a nominal rate judged to reflect
its high risk
• For the purposes of evaluation, assume the year 3 nominal cash flows will continue to
be earned each year indefinitely.

Note: Ignore taxation.


Assume that you are the Financial Manager of KH. Prepare a report to the Finance Director
that evaluates the proposed investment. Include in your report the following:

(a) Calculation of the net present value of the proposed investment and a recommenda-
tion as to whether the company should proceed with the investment, supported by
your reasons for the recommendation.

(12 marks)

(b) Discussion of the main political risks that might be faced by the company and provision
of advice on management strategies that could be implemented to counter those risks.

(13 marks)
25 marks)

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