Valuing Metallwerke's Contract with Safe Air, Inc.
Consider the discounted expected value of the 10- year contract that Metallwerke may sign with Safe Air in Chapter 9. In the initial year of the deal, Metallwerke sells an air tank to Safe Air for $400. It costs :238 to produce an air tank. The current exchange rate is $1.40 >:. Assume that 15,000 air tanks will be sold the first year. Make the following other assumptions in your valuation:
a. 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.
b. Euro-denominated costs are expected to increase at the euro rate of inflation of 2%.
c. The base dollar price of the air tank will be increased at the U.S. rate of inflation plus one-half of any real depreciation of the dollar relative to the euro, but the base dollar price will be reduced by one-half of any appreciation of the dollar rela- tive to the euro. The U.S. rate of inflation is ex- pected to be 4%.
d. The dollar is currently not expected to strengthen or weaken in real terms relative to the euro.
e. The German corporate income tax rate is 30%.
f. The appropriate euro discount rate for the project is 12%.
g. Metallwerke typically establishes an account receivable for its customers. At any given time, the stock of the account receivable is expected to equal 10% of a given year's revenue.
h. Accepting the Safe Air project will not require any major capital expenditures by Metallwerke.
Can you determine the value of the contract to Metallwerke?