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Hi John,
For the APV calculation in question Tramont, the debt-related cash flows were all converted into USD and discounted at 5%. I ahve following questions relating to this
1. I dont understand why we discount at this rate. Tramont has to borrow in the foreign country, and the normal rate that it can borrow is 13%. Shouldn’t we discount the debt-related cash flows at this rate of 13% and then convert the result at exchange rate at Year 0?
2. The 2 countries have different tax rates. The debt is taken in the foreign country with tax 20% while the home country US has tax at 30%. Why dont we have to consider the additional tax of 10% when calculating the NPV of the tax relief and tax savings?
3. The total Year 0 investment required in the foreign country is GR 270m. However, at the same time if we undertake this overseas investment, we will sell off the assets in US and get a net cash inflow of $600k, converting to GR 33m. Then, shouldn’t our required debt for initial investment be only 270 – 33 = GR 237m? The answer is taking the debt as GR 270m instead
Thank you
1. There are arguments for discounting the tax saving at either the return on debt borrowing or at the risk free rate, and as I explain in my lectures the examiner always accepts either. However, 13% would not be sensible because they will not actually be paying 13%.
2. The tax saved on the interest is tax saved in the foreign country which is at 20%.
3. I take your point, but since the question refers to financing the project it is better to assume that the whole project is financed by the borrowing and not take into account any proceeds from elsewhere.
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