Miller is evaluating a plan to brew and market a new porter beer in Europe. The
ID: 2706567 • Letter: M
Question
Miller is evaluating a plan to brew and market a new porter beer in Europe. The new beer will be test marketed for 1 year in Belgium, with up front costs of (euro)20 million. No profits will be generated by the test market. There is a 50% chance that the test phase will warrant an additional (euro)400 million investment. The expected annual after-tax cash flow for the new beer in Europe is expected to be (euro)100 million per year for 15 years. If the test phase fails, the project will be abandoned. A required rate of return of 12.5% is required for the (euro)400 million investment. Since the test-market is speculative, the CFO believes that the firm should use a discount rate of 25% to determine the NPV for the decision to test market the product. The exchange rate between the DOLLAR and EURO is $1.6/(euro)1. Assuming the risk-free EURO-denominated interest rate is 4.5% per year and the risk-free US interest rate is 1.5% per year, determine the NPV for the investment in test marketing the product.
Explanation / Answer
IF THE TEST PHASE SUCCEDS
YEARS CASHFLOWS(IN EURO MILLIONS) PRESENT VALUE @ 25% (IN EURO MILLIONS)
0 (20) (20)
1 (400) (256)
2 100 64
3 100 51.2
4 100 40.96
5 100 32.77
6 100 26.21
7 100 20.97
8 100 16.78
9 100 13.42
10 100 10.74
11 100 8.59
12 100 6.87
13 100 5.5
14 100 4.4
15 100 3.52
16 100 2.81
NPV= 32.74 (IN EURO MILLIONS)
IF THE TEST FAILS, THE PROJECT WILL BE ABANDONED AND THERE WILL BE ONLY ONE CASH OUTFLOW OF EURO 20 MILLION
THEREFORE NPV = (20) ( IN EURO MILLIONS)
PARTICULARS PROBALITY NPV
a]TEST SUUCCEDS 0.5 32.74
b]TEST FAILS 0.5 (20)
THEREFORE, PROBABLE NPV OF THE PROJECT = 32.74*0.5 + (20)*0.5
=EURO 6.37 MILLION
SINCE EVERY FIGURE IS IN EURO WE CAN EVALUTE THE PROJECT
SINCE PROBABLE NPV IS POSITIVE THE COMPANY SHOULD ACCEPT THE PROJECT