John Cromwell is the 54-year-old CEO of Safe Air, Inc., a U.S. corporation that sells compressed air tanks with face masks to U.S. fire departments. Safe Air’s masks are the best available, and Cromwell has often stated that Safe Air has no expertise in manufacturing air tanks. It consequently has always purchased tanks from an external supplier. Safe Air’s board of directors has begun to question Cromwell’s leadership because earnings have been declining. Cromwell thinks he is too young to retire and being forced out by the board would be humiliating. In order to cut costs, he solicited bids from potential suppliers of tanks. In particular, Metallwerke, A.G., a German firm that manufactures air tanks, submitted an attractive contract that offered dollar pricing. Cromwell is intrigued by the possibility of locking in long-term dollar prices from a lowcost foreign supplier. He has evaluated the quality of Metallwerke’s tanks and thinks they are as good as, if not superior to, that of Safe Air’s current U.S. supplier. If the Metallwerke air tank works better than his current tank, he knows that fire departments will probably pay more for the improved performance.

You are the corporate finance analyst with Metallwerk and you have been asked to compute the discounted expected value of a 10-year sales contract with Safe Air. Entering 2 into the contract requires no initial capital outlay. In the initial year of the deal, Metallwerke sells an air tank to Safe Air for USD400. It costs EUR238 to produce an air tank. The current exchange rate is USD/EUR 1.40. Assume that 15,000 air tanks will be sold the first year.

Make the following other assumptions in your valuation:

• The demand for air tanks is expected to grow at 5% for the second year, 4% for the third and fourth years, and 3% for the remaining life of the contract.

• Euro-denominated costs are expected to increase at the euro rate of inflation of 2%.

• The base dollar price of the air tank will increase at the U.S. rate of inflation. The U.S. rate of inflation is expected to be 4%.

• The German corporate income tax rate is 30%.

• The appropriate euro discount rate for the project is 12%.

• At any given time, net working capital is expected to equal 10% of a given year’s revenue.

• Accepting the Safe Air project will not require any major capital expenditures by Metallwerke.

• Depreciation of property, plant, and equipment is negligible.

What is the value of the sales contract to Metallwerk in EUR? (Hint: Use free cash flow to perform the valuation. Present your valuation in an Excel spreadsheet)

Answer rating: 100% (QA)

The value of the sales contract to Metallwerk in EUR is 103447396 The following is a stepbystep solu... View the full answer