GZ plc plans to build a factory in the USA for $3.4m. Additional investment in working capital
Question:
GZ plc plans to build a factory in the USA for $3.4m. Additional investment in working capital of $500 000 would be needed and this would be financed by a loan from a US bank of $500 000. Annual before-tax cash flows of $1m per year in current price terms would be expected from the sale of goods made in the new factory.
Profit tax in the USA would be at a concessionary rate of 15 per cent per year for a period of five years, which is also the planning horizon used by GZ plc. The company can claim capital allowances on the investment of $3.4m on a 25 per cent reducing balance basis. Profit tax in the UK is at an annual rate of 30 per cent per year.
A double taxation agreement exists between the two countries and tax liabilities are paid in the year in which they arise in both the USA and the UK. The current exchange rate is $1.70/ £ and the US dollar is expected to depreciate against sterling by 5 per cent per year.
GZ plc has an after-tax nominal (money) cost of capital of 15 per cent. Annual inflation in the USA is expected to be 3 per cent per year for the foreseeable future.
At the end of its five-year planning horizon, GZ plc expects the US factory to have a market value of $5m.
(a) Calculate whether GZ plc should build the factory in the USA.
(b) Calculate and discuss whether $5m is an acceptable estimate of the market value of the factory in five years’ time.
Step by Step Answer:
Corporate Finance Principles And Practice
ISBN: 9780273725343
5th Edition
Authors: Denzil Watson, Antony Head