Daily Archives: June 9, 2021

What is the present value of the project in EUR?

McCain Foods, a Canadian food processing and distribution company, is considering an investment in Germany. You are in McCain’s corporate finance department and are responsible for deciding whether to undertake the project. The expected free cash flows, in EUR, are uncorrelated to the spot exchange rate and are shown here:

The new project has similar dollar risk to McCain’s other projects. Management at the company knows that its overall CAD WACC is 9.5% and so is comfortable using this WACC for the project. The risk-free interest rate on CAD is 4.5% and the risk-free interest rate on EUR is 7%.

a. McCain is willing to assume that capital markets in Canada and the European Union are internationally integrated. What is the company’s EUR WACC?

b. What is….

What is Tailor Johnson’s U.S. tax liability on its Ethiopian subsidiary?

Tailor Johnson, a U.S. maker of fine menswear, has a subsidiary in Ethiopia. This year, the subsidiary reported and repatriated earnings before interest and taxes (EBIT) of 100 million ETB (Ethiopian birrs). The current exchange rate is 8 ETB/ USD or 0.125USD/ETB. The Ethiopian tax rate on this activity is 25%. Tax law in the United States requires Tailor Johnson to pay taxes on the Ethiopian earnings at the same rate as profits earned in the United States, which is currently 45%. However, the United States gives a full tax credit for foreign taxes paid up to the amount of the U.S. tax liability. What is Tailor Johnson’s U.S. tax liability on its Ethiopian subsidiary?

What is the present value of deferring the U.S. tax liability on Tailor Johnson’s Ethiopian earnings for 10 years?

Tailor Johnson, the menswear company with a subsidiary in Ethiopia described in Problem 13 is considering the tax benefits resulting from deferring repatriation of the earnings from the subsidiary. Under U.S. tax law, the U.S. tax liability is not incurred until the profits are brought back home. Tailor Johnson reasonably expects to defer repatriation for 10 years, at which point the ETB earnings will be converted into USD at the prevailing spot rate, S10, and the tax credit for Ethiopian taxes paid will still be converted at the current exchange rate = 0.125 USD/ETB. Tailor Johnson’s after-tax cost of debt is 5%.

a. Suppose the exchange rate in 10 years is identical to this year’s exchange rate, so S10 = 0.125 USD/ETB. What is the present value of deferring….

What is the Canadian tax liability on the earnings from the Polish subsidiary assuming the Swedish subsidiary did not exist?

Qu’Appelle Enterprises, a Canadian real-estate investment firm, is considering its international tax situation. Canadian tax law requires Canadian corporations to pay taxes on their foreign passive income at the same rate as profits earned in Canada; this rate is currently 35%. However, a full tax credit is given for the foreign taxes paid up to the amount of the Canadian tax liability. Qu’Appelle has major operations in Poland, where the tax rate is 20%, and in Sweden, where the tax rate is 60%. The profits, which are fully and immediately repatriated and foreign taxes paid for the current year are shown here:

a. What is the Canadian tax liability on the earnings from the Polish subsidiary assuming the Swedish subsidiary did not exist?

b. What is the….

Export the yields into Excel into the same spread sheet as the other data. Add the one-year yield to the other Treasury rates.

You may have noticed that the one-year and four-year rates are not available at Bloomberg.com for the U.S. Treasury. Go to the U.S. Treasury website (www.treas.gov).

a. To find the one-year rate, type “yield curve” into the search box at the top of the page and select the second link that appears. Be sure it is not the link for the “real” rates. Export the yields into Excel into the same spread sheet as the other data. Add the one-year yield to the other Treasury rates.

b. To find an estimate of the four-year yield, calculate the average of the threeand five-year yields from the Treasury yield curve.

What are the free cash flow consequences of buying the fabricator?

Craxton Engineering will either purchase or lease a new $756,000 fabricator. If purchased, the fabricator will be depreciated for tax purposes on a straight-line basis over seven years. Craxton can lease the fabricator for $130,000 per year for seven years. Craxton’s tax rate is 35%. (Assume the fabricator has no residual value at the end of the seven years.)

a. What are the free cash flow consequences of buying the fabricator?

b. What are the free cash flow consequences of leasing the fabricator if the lease is a true tax lease?

c. What are the incremental free cash flows of leasing versus buying?

If Riverton purchases the equipment, what is the amount of the lease-equivalent loan?

Riverton Mining plans to purchase or lease $220,000 worth of excavation equipment. If purchased, the equipment will be depreciated for tax purposes on a straightline basis over five years, after which it will be worthless. If leased, the annual lease payments will be $55,000 per year for five years. Assume Riverton’s borrowing cost is 8%, its tax rate is 35%, and the lease qualifies as a true tax lease.

a. If Riverton purchases the equipment, what is the amount of the lease-equivalent loan?

b. Is Riverton better off leasing the equipment or financing the purchase using the lease-equivalent loan?

c. What is the effective after-tax lease borrowing rate? How does this compare to Riverton’s actual after-tax borrowing rate?

If Clorox will depreciate (for tax purposes) the computer equipment on a straight-line basis over the next five years, and if the lease qualifies as a true tax lease, is it better to finance the purchase of the equipment or to lease it?

Suppose Clorox can lease a new computer data processing system for $975,000 per year for five years. Alternatively, it can purchase the system for $4.25 million. Assume Clorox has a borrowing cost of 7% and a tax rate of 35%, and the system will be obsolete at the end of five years.

a. If Clorox will depreciate (for tax purposes) the computer equipment on a straight-line basis over the next five years, and if the lease qualifies as a true tax lease, is it better to finance the purchase of the equipment or to lease it?

b. Suppose that if the Clorox Canada division buys the equipment, it will use capital cost allowance for depreciation tax purposes. Specifically, the CCA rate will be 45% and any undercoated capital….

What is the NPV associated with leasing the equipment versus financing it with the lease-equivalent loan?

Suppose Procter and Gamble (P&G) is considering purchasing $15 million in new manufacturing equipment. If it purchases the equipment, P&G will depreciate it for tax purposes on a straight-line basis over five years, after which the equipment will be worthless. P&G will also be responsible for maintenance expenses of $1 million per year. Alternatively, it can lease the equipment for $4.2 million per year for the five years, in which case the lessor will provide necessary maintenance. Assume P&G’s tax rate is 35% and its borrowing cost is 7%.

a. What is the NPV associated with leasing the equipment versus financing it with the lease-equivalent loan?

b. What is the break-even lease rate—that is, what lease amount could P&G pay each year and be indifferent about leasing versus….

What is the lease rate for which the lessor will break even?

Suppose Netflix Canada is considering the purchase of special software to facilitate its enhancement of video-on-demand services. In total, the firm will purchase $48 million in new software. This software will qualify for CCA deductions at a rate of 100%. However, because of the firm’s substantial loss carry forwards, Netflix estimates its marginal tax rate to be 10% over the next five years, so it will get very little tax benefit from the CCA deductions. Thus Netflix considers leasing the software instead. Suppose Netflix and the lessor face the same 8% borrowing rate, but the lessor has a 40% tax rate. For the purpose of this question, assume the software is worthless after five years, the lease term is five years, and the lease qualifies as a true….