Chofu Fukuhara is the production manager of Asahi Chemicals, a Japanese chemical manufacturer operating throughout Southeast Asia. Fukuhara-san is considering building a chemical plant in Thailand to service the growing Southeast Asian market. The attractiveness of the project depends on the following.
The exchange rate is currently .
The factory will cost Bt4 million and will take one year to construct. Assume the Bt4 million cost of the investment will be paid in full at the end of one year.
The real value of the factory is expected to remain at Bt4 million (in time baht) throughout the life of the project.
The plant will be sold at project end.
Production begins in one year (at time 1) with annual revenues of Bt100 million per year (in nominal terms) over the 4-year life of the project. Fixed operating expenses are set by contract in nominal terms at Bt5 million each year over the 4-year life of the project. The last year of production is year 5.
Variable costs are 90 percent of gross revenues. Assume endof-year cash flows.
The plant will be owned by a subsidiary in Thailand. Annual depreciation will be Bt1 million in years 2 through 5.
Taxes are 40 percent in both Thailand and Japan.
Annual inflation expectations are percent in Thailand and percent in Japan.
The nominal required return on similar Thai projects is percent.
Assume that the international parity conditions hold.

a. Calculate the value of this investment proposal from the local (Thai baht) perspective.

b. What is the nominal required return on similar projects in Japan?

c. Identify the expected future spot exchange rates for each cash flow.

d. Calculate the yen value of the project using capital budgeting recipes #1 and #2. Are the answers equivalent?
Why?

Cross-border capital budgeting when international parity does not hold.