Duncan Street Company (DSC), a British company, is considering establishing an operation in the United States to assemble and distribute smart speakers. The initial investment is estimated to be 25,000,000 British pounds (GBP), which is equivalent to 30,000,000 U.S. dollars (USD) at the current exchange rate. Given the current corporate income tax rate in the United States, DSC estimates that total after-tax annual cash flow in each of the three years of the investment’s life would be US$10,000,000, US$12,000,000, and US$15,000,000, respectively. However, the U.S. national legislature is considering a reduction in the corporate income tax rate that would go into effect in the second year of the investment’s life and would result in the following total annual
The U.S. operation will distribute 100 percent of its after-tax annual cash flow to DSC as a dividend at the end of each year. The terminal value of the investment at the end of three years is estimated to be US$25,000,000. The U.S. withholding tax on dividends is 5 percent; repatriation of the investment’s terminal value will not be subject to U.S. withholding tax. Neither the dividends nor the terminal value received from the U.S. investment will be subject to British income tax.
Exchange rates between the GBP and USD are
Required:
- a. Determine the expected
net present value of the potential U.S. investment from a project perspective. - b. Determine the expected net present value of the potential U.S. investment from a parent company perspective.
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International Accounting
- Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR11,200. The annual cash flows over the five-year economic life of the project in ZAR are estimated to be 3,360, 4,360, 5,350, 6,340, and 7,300. The parent firm’s cost of capital in dollars is 9.5 percent. Long-run inflation is forecasted to be 3 percent per annum in the United States and 7 percent in South Africa. The current spot foreign exchange rate is ZAR/USD = 3.75. Calculating the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher effect and then converting to USD at the current spot rate. Converting all cash flows from ZAR to USD at purchasing power parity forecasted exchange rates and then calculating the NPV at the dollar cost of capital. Are the two dollar NPVs different or the same? multiple choice Different Same 4.What is the NPV in dollars if the actual pattern of ZAR/USD exchange rates is: S(0) = 3.75, S(1) =…arrow_forwardDelta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR12,600. The annual cash flows over the five-year economic life of the project in ZAR are estimated to be 3,780, 4,780, 5,770, 6,760, and 7,650. The parent firm's cost of capital in dollars is 9.5 percent. Long-run inflation is forecasted to be 3 percent per annum in the United States and 7 percent in South Africa. The current spot foreign exchange rate is ZAR per USD = 3.75. Required: Complete this question by entering your answers in the tabs below. Required A Required B Required C Required D Calculating the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher effect and then converting to USD at the current spot rate. Note: Do not round the intermediate calculations. Round the final answer to the nearest whole number. NPV in USD using fisher effect a. Calculating the NPV in ZAR using the ZAR equivalent cost of capital…arrow_forwardThe South Korean multinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The project's expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $700,000 in Year 1 and $600,000 in Year 2. The risk-adjusted cost of capital for this project is 12%. The current exchange rate is 1,055 won per U.S. dollar. Risk-free interest rates in the United States and S. Korea are: % U.S. S. Korea a. If this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value generated by this project? Do not round intermediate calculations. Round your answer to the nearest dollar. $ What would be the rate of return generated by this project? Do not round intermediate calculations. Round your answer to two decimal places. 1-Year 4.0% 3.0% Rate of return: 2-Year 5.25% 4.25% b. What is the expected forward exchange rate 1…arrow_forward
- Suppose that Kittle Co. is a U.S. based MNC that is considering setting up a subsidiary in Singapore. Kittle would like this subsidiary to produce and sell guitars locally in Singapore, and needs assistance with capital budgeting. The duration of this project is four years, with a salvage value of $12,000,000. This salvage value would be paid by the government in Singapore to Kittle in exchange for ownership of the subsidiary. The expected exchange rate of the Singapore dollar of $0.50 over the life of the project. Kittle managers are worried about the uncertainty of the value of the Singapore dollar. While they expect that the exchange rate will be $0.50, they recognize that this value may fluctuate. Thus, they decide to S$3,000,000 in cash flows per year, while any additional cash flows beyond this threshold would not be hedged. The forward rate that Kittle will use to hedge the S$3,000,000 is $0.48. The following table shows a key subsection of Kittle's capital budgeting analysis…arrow_forwardGlobal Electronics Inc. invested $1,000,000 to build a plant in a foreign country. The labor and materials used in production are purchased locally. The plant expansion was estimated to pro-duce an internal rate of return of 20% in U.S. dollar terms. Due to a currency crisis, the currency exchange rate between the local currency and the U.S. dollar doubled from two local units per U.S. dollar to four local units per U.S. dollar. Write a brief memo to the chief financial officer, Tom Greene, explaining the impact that the currency exchange rate change would have on the project’s internal rate of return if (1) the plant produced and sold product in the local economy only, and (2) the plant produced all product locally and exported all product to the United States for sale.arrow_forwardSuppose that Kittle Co. is a U.S. based MNC that is considering setting up a subsidiary in Singapore. Kittle would like this subsidiary to produce and sell guitars locally in Singapore, and needs assistance with capital budgeting. The duration of this project is four years, with a salvage value of $12,000,000. This salvage value would be paid by the government in Singapore to Kittle in exchange for ownership of the subsidiary. The expected exchange rate of the Singapore dollar of $0.50 over the life of the project. Kittle managers are worried about the uncertainty of the value of the Singapore dollar. While they expect that the exchange rate will be $0.50, they recognize that this value may fluctuate. Thus, they decide to S$3,000,000 in cash flows per year, while any additional cash flows beyond this threshold would not be hedged. The forward rate that Kittle will use to hedge the S$3,000,000 is $0.48. The following table shows a key subsection of Kittle's capital budgeting analysis…arrow_forward
- ABC Inc. is a US company that is considering moving its manufacturing facility to Mexico. The Mexican subsidiary manufactures toys for kids which will be sold to Mexican households in big cities. The cost to purchase and equip the facility is 20,000,000 Mexican pesos. The company's production, administrative and sales department have supplied the estimates of earnings and annual changes in net working capital, interest rates in Mexico and the US, the current peso/dollar exchange rate as follows: year US interest rate Mexico's interest rate Pesos per dollar Initial investment EBIT Change in net working capital Capital expenditure Unit: Mexican Peso 0 18 -20,000,000 1 2 3 1.50% 1.50% 1.50% 7.25% 7.25% 7.25% 100,000 140,000 948,000 250,000 40,000 40,000 0 0 Perform an NPV analysis to determine whether this is a good investment, under the following assumptions: a) The peso/dollar exchange rate is currently 18pesos/$, and the peso is expected to appreciate/depreciate at a rate justified by…arrow_forwardSmart banking corp can borrow $5 million at 6 percent annualized.it can use the proceeds to invest in Canadian dollars at 9 percent annualized over a 6-day period. The canadian dollar is worth $.95 and is expected to be worth $.96 in 6 days. Based on this information, should smart banking corp. Borrow U.S dollars and invest in Canadian dollars? What would be the gain or loss in U.S dollars?arrow_forwardSmart Banking Corp. can borrow $5 million at 6 percent annualized. It can use theproceeds to invest in Canadian dollars at 9 percent annualized over a 6-day period. TheCanadian dollar is worth $.95 and is expected to be worth $.94 in 6 days. Based on thisinformation, should Smart Banking Corp. borrow U.S. dollars and invest in Canadiandollars? What would be the gain or loss in U.S. dollars?arrow_forward
- Consider this case: Sebrele Enterprises Inc. is a U.S. firm evaluating a project in Australia. You have the following information about the project: The project requires an investment of AU$915,000 today and is expected to generate cash flows of AU$900,000 at the end of each of the next two years. The current exchange rate of the U.S. dollar against the Australian dollar is $0.7823 per Australian dollar (AUS). The one-year forward exchange rate is $0.8102 / AU$, and the two-year forward exchange rate is $0.8412 / AU$. The firm's weighted average cost of capital (WACC) is 9.5%, and the project is of average risk. What is the dollar-denominated net present value (NPV) of this project? $610,602 $726,908 $581,526 $639,679arrow_forwardA U.S. firm is considering purchasing a subsidiary in the UK. The subsidiary will cost 6M British pounds and will generate cash inflows of 1.2M pounds per year forever. The current exchange rate is 0.8 pounds/$. The average inflation rate is expected to be 2% in the US. The current risk-free rate of interest is 4% in the US and 9% in the UK. Assume the cost of capital for this project is 10% on dollar investments. What is the approximate discount rate you would use to discount the cash flows if you were to evaluate this project using the foreign currency approach? 5% 13% 10% 15% 9%arrow_forwardarpet Baggers Inc. is proposing to construct a new bagging plant in a country in Europe. The two prime candidates are Germany and Switzerland. The forecasted cash flows from the proposed plants are as follows: The spot exchange rate for euros is $1.3/€, while the rate for Swiss francs is CHF 1.5/$. The interest rate is 5% in the United States, 4% in Switzerland, and 6% in the euro countries. The financial manager has suggested that, if the cash flows were stated in dollars, a return in excess of 10% would be acceptable. Should the company go ahead with either project? What is the NPV of the projects? If it must choose between them, which should it take? The table is attached to this question. Be comprehensive when Justifying your answer. Thank you.arrow_forward