Inc. is ad ing Mexico. The Mexican subsidiary manufactures toys for kids which will be sold to Mexican households in big cities. The cost to purchase and equip the facility is 20,000,000 Mexican pesos. The company's production, administrative and sales department have supplied the estimates of earnings and annual changes in net working capital, interest rates in Mexico and the US, the current peso/dollar exchange rate as follows: year US interest rate Mexico's interest rate Pesos per dollar Initial investment 0 18 -20,000,000 1 1.50% 7.25% 2 3 1.50% 1.50% 7.25% 7.25%

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Chapter1: Investments: Background And Issues
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ABC Inc. is a US company that is considering moving its manufacturing facility to
Mexico. The Mexican subsidiary manufactures toys for kids which will be sold to
Mexican households in big cities. The cost to purchase and equip the facility is
20,000,000 Mexican pesos. The company's production, administrative and sales
department have supplied the estimates of earnings and annual changes in net working
capital, interest rates in Mexico and the US, the current peso/dollar exchange rate as
follows:
year
US interest rate
Mexico's interest rate
Pesos per dollar
Initial investment
EBIT
Change in net working capital
Capital expenditure
Unit: Mexican Peso
0
18
-20,000,000
1
2
3
1.50%
1.50%
1.50%
7.25% 7.25% 7.25%
100,000 140,000 948,000
250,000 40,000 40,000
0
0
Perform an NPV analysis to determine whether this is a good investment, under the
following assumptions:
a) The peso/dollar exchange rate is currently 18pesos/$, and the peso is expected
to appreciate/depreciate at a rate justified by the expected basic interest rate
differential between Mexico and the United States.
b) Depreciation of the fixed assets worth 20,000,000 peso initially invested in year
0 will be taken on a straight-line basis over 20 years.
c) The Mexico corporate income tax rate is 30%, and there is a 10% withholding tax
on dividends payments.
d) The dollar-denominated discount rate for the project is 15%.
e) All the Mexican subsidiary's free cash flows will be paid to the US parent as
dividends.
f) All earnings repatriated to the US are subject to the US Tax Cuts and Jobs Act
2017.
g) After year 3, the dollar free-cash flows for the US parent will grow at a constant
rate of 1% per year forever.
Transcribed Image Text:ABC Inc. is a US company that is considering moving its manufacturing facility to Mexico. The Mexican subsidiary manufactures toys for kids which will be sold to Mexican households in big cities. The cost to purchase and equip the facility is 20,000,000 Mexican pesos. The company's production, administrative and sales department have supplied the estimates of earnings and annual changes in net working capital, interest rates in Mexico and the US, the current peso/dollar exchange rate as follows: year US interest rate Mexico's interest rate Pesos per dollar Initial investment EBIT Change in net working capital Capital expenditure Unit: Mexican Peso 0 18 -20,000,000 1 2 3 1.50% 1.50% 1.50% 7.25% 7.25% 7.25% 100,000 140,000 948,000 250,000 40,000 40,000 0 0 Perform an NPV analysis to determine whether this is a good investment, under the following assumptions: a) The peso/dollar exchange rate is currently 18pesos/$, and the peso is expected to appreciate/depreciate at a rate justified by the expected basic interest rate differential between Mexico and the United States. b) Depreciation of the fixed assets worth 20,000,000 peso initially invested in year 0 will be taken on a straight-line basis over 20 years. c) The Mexico corporate income tax rate is 30%, and there is a 10% withholding tax on dividends payments. d) The dollar-denominated discount rate for the project is 15%. e) All the Mexican subsidiary's free cash flows will be paid to the US parent as dividends. f) All earnings repatriated to the US are subject to the US Tax Cuts and Jobs Act 2017. g) After year 3, the dollar free-cash flows for the US parent will grow at a constant rate of 1% per year forever.
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