Sima Plc is a UK company based in Bristol. The company has been investing in domestic projects since it was established. It is now considering a four-year project in the country of Ramisi. Ramisi is rich in gold and this will be the first international mining project for Sima Plc. The company will invest R$80 billion in machinery and this will have a scrap value of R$10 billion at the end of the project. R$20 billion is required in working capital expected to increase at R$2bn per year. Working capital will be recovered in the final year of the project.
The mining and refining of gold will be undertaken in Ramisi. The project is expected to generate annual sales of R$90 billion in year one and the sales will increase at a rate of 5% per annum. Sima PLC will charge the overseas subsidiary £1.1 billion sterling pounds of management fees each year. The variable direct costs are expected to be as follows:
UK corporation tax is 19% and payable one year in arrears. Ramisi corporation tax is 21% and is payable immediately. UK inflation is expected to be 3% per annum and Ramisi inflation is expected to be 5% per annum. Tax allowable depreciation is on a straight-line basis and any residual value will be taxable at 21%. There is no extra tax payable in the UK. The current spot rate is R$20 / £1.
Sima PLC uses a discount rate of 12% on projects with the same level of risk as the investment in Ramisi.
Estimate the net present value of the project in £ billion, using the nominal rate method.
The finance director of Sima Plc has been insisting on the use of NPV to make investment decisions. Identify the limitations of NPV and recommend whether the project should be undertaken.
Give advice to the management of Sima PLC on factors to consider when investing in Ramisi.
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