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Hi sir,
Extract from question :-
‘Bongolong Plc has their head office in London, considering investing in Mexico…
The investment will require equipment costing 1.625 mil pounds and working capital of 1 mil pounds.
Bongolong proposes to finance the equipment expenditure with a 65 mil peso 5-year term loan at 12% from the Bank of Mexico, whilst the working capital will be financed by exporting sterling…’
(a) The tutorial answer only takes in the peso loan but not the sterling loan in the investment appraisal. What is the reason for this…?
(b) The interest on peso loan of 7.8 mil peso per annum…should we assume it to be payable in advance or in arrears…?…Nothing is mentioned in the question with regards to this…The tutorial answer however takes it as first interest payment in Time 1 instead of Time 0…
Thanx…~
I cannot answer with certainty because I do not have this question.
For (a) I would need to see the whole question .
For (b) it would be normal to assume that interest was paid at the ends of years (it would be very strange in any situation to have to pay interest at the start of years).
Hi sir,
Here is the whole question :-
‘Bongolong Plc manufactures agricultural machinery and has their head office in London. The directors are currently considering investing in a small manufacturing facility in Mexico to serve both the North and South Americas.
If the decision is taken to go ahead, the project would commence immediately. It will require equipment costing 1.625 mil pounds and working capital of 1 mil pounds. The project should have a five-year life, at the end of which time the equipment, net of dismantling costs, is expected to have a zero value. The working capital would all be recovered.
Bongolong proposes to finance the equipment expenditure with a 65 mil peso 5-year term loan at 12% from the Bank of Mexico, whilst the working capital will be financed by exporting sterling.
The manufacturing facility is expected to produce a net cash flow, before tax and interest, of 25 mil pesos in the first year, and this is expected to increase by 10% per year.
In Mexico, corporation tax is charged at a rate of 50% on the annual net cashflow after interest charges and straight-line depreciation. In addition, Bongolong have negotiated a concession with the Mexican government to allow a notional annual interest charge of 15% per year on the exported sterling used to finance working capital.
Tax is paid twelve months after each year-end and tax losses can be carried forward and set-off against future tax liabilities. The Mexican government has undertaken to allow Bongolong to remit all cash surpluses and deficits to the UK at each year-end. Bongolong’s tax adviser has indicated that no additional UK tax will be payable on UK-remitted funds.
The current Mexico peso/pounds spot exchange rate is 40.00. Bongolong’s treasury department has estimated that the peso is likely to appreciate against sterling by two pesos per year in each of the next two years and then appreciate by one peso per year in each of the following two years and thereafter remain stable.
Agricultural machinery manufacturing is expected to produce anannual return of around 20% in the UK.’
thanks…~
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