Assume that the American Electrical Corporation (AEC) is considering the establishment of a freezer manufacturing plant in Spain. AEC wants to invest a total of 10,000 Spanish pesetas in the proposed plant. The Pts10,000 will be financed with only common stock, all of which will be owned by the parent company. The plant is to be depreciated over a 5-year period on a straight-line basis for tax purposes. It is expected to have a salvage value of Pts5,000 at the end of 5 years. Spain has 35 percent corporate income tax and no withholding taxes on dividends paid. The USA has 50 percent corporate income tax with direct credit for Spanish taxes. Spain does not impose any restrictions on dividend repatriation, but it does not allow the parent company to repatriate depreciation cash flows until the plant is liquidated. These depreciation cash flows may be reinvested in Spanish government bonds to earn 8 percent tax-exempt interest. The cost of capital used to analyze the project is 15 percent. The current exchange rate of Pts5.00 per US dollar is expected to hold during year 1, but the Spanish peseta is expected to depreciate thereafter at a rate of 5 percent a year. Assume the following revenues and operating costs in terms of Spanish pesetas:

(a) Determine the projected earnings after taxes for the proposed plant.

(b) Determine the interest-compounded depreciation cash flows at the end of 5 years.

(c) Determine the net present value of the plant, the profitability index, and the internal rate of return for the plant in terms of the US dollar.

Transcribed Image Text:

Year 1 Year 2 Year 3 Year 4 Year 5 Revenues Operating 10,000 11,000 12,000 13,000 14,000 6,000 6,000 7,000 7,000 8,000 costs