Alcala de Henares Caso

Case 2: MSDI – Alcala de Henares, Spain

For all three questions, assume the followings:

- All international parity conditions hold (unless otherwise stated)

- Merck’s weighted average cost of capital is 15% for a similar U.S. project

- U.S. annual inflation rate is expected to be 5%

Question 1

Should Merck invest in the new photoelectric inspection equipment?

Question 2

Suppose the International Fisher Relation does not hold, i.e., the Spanish weighted average cost of capital is 25%.

Should Merck invest in the new photoelectric inspection equipment?

Q1.

Merk Sharp and Dohme International (MSDI) should invest in the new photoelectric inspection equipment in Madrid, Spain. They should make this investment, unless there is another that would offer a higher net present value, which might be true of the similar US project, considering cost of capitol is lower in the US by more than 3 percentage points. It is not possible to say it is more attractive, however without knowing more specifics about the US project. Considering everything that the Madrid project has going for it, MSDI should invest in it.

The Madrid proposal has many attractive properties, including fewer workers, that require less expensive training, which results in direct labor savings. The old way needed 10 people working a shift while the new method would require only 3-4 people working the inspection. Using the new equipment would also remove human error from the process, reducing rejection rates from 11% down to 3%. All of the advantages are nice to have, but with this operation the main issue was will it provide the company with a positive net present value, when the project is all said and done.

The issue of what currency to compute the discounted cash flows analysis currency is unnecessary since it would not matter in the final outcome of the NPV. Also the speculation that the peseta would appreciate over the coming years is a positive note, but...