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MegaWash, Inc., is considering an expansion of their product line to Mexico. This would require a...

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MegaWash, Inc., is considering an expansion of their productline to Mexico. This would require a purchase of equipment with aprice of 3,000,000MXN and additional installation of 500,000MXN, tobe depreciated straight-line to zero over the 5-year life of theasset. They will not be replacing any existing equipment. Theirrequired rate of return is 15% and they are in the 35% tax bracket.The new product line is expected to increase sales by 800,000MXNper year over current levels for the next 5 years, and expenseswill increase by 400,000MXN. Assume the after-tax operating cashflows in years 1-5 are equal, and the terminal value of the projectin year 5 may change total after-tax cash flows for that year. Theequipment is multipurpose, and the company anticipates that theywill sell it at the end of the five years for 600,000MXN. Theinitial investment also requires an increase in Net Working Capital(NWC) of 150,000MXN (to be recovered at the sale of the equipmentat the end of five years). The current spot rate is $0.75/MXN, andthe expected inflation rate in the U.S. is 3% per year and 2% peryear in Mexico.

Question: What is the IRR of the MegaWashexpansion?

Answer & Explanation Solved by verified expert
4.2 Ratings (565 Votes)

MegaWash 0 1 2 3 4 5
USD/MXN $             0.750 $      0.757 $      0.765 $         0.772 $      0.780 $      0.787
Investment -3,500,000
NWC -150,000 150,000
Salvage 600,000
Sales 800,000 800,000 800,000 800,000 800,000
Expenses -400,000 -400,000 -400,000 -400,000 -400,000
Depreciation -700,000 -700,000 -700,000 -700,000 -700,000
EBT -300,000 -300,000 -300,000 -300,000 -300,000
Tax (35%) 105,000 105,000 105,000 105,000 105,000
Net Income -195,000 -195,000 -195,000 -195,000 -195,000
CF (MXN) -3,650,000 505,000 505,000 505,000 505,000 1,045,000
CF (USD) -$2,737,500 $382,463 $386,213 $389,999 $393,823 $822,930
IRR -4.06%

Forward exchange rate (USD/MXN) = Spot rate x (1 + US rate) / (1 + MX rate) = 0.750 x 1.03 / 1.02 = $0.757 / MXN and so on for other years

Depreciation = 3,500,000 / 5 = 700,000

CF (MXN) = Investment + NWC + Salvage x (1 - tax) + Net Income + Depreciation

CF (USD) = CF (MXN) x USD / MXN

IRR can be calculated using the same function on a calculator or excel given the cash flows.
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