Problems 1 and 2 highlight the complexities involved in foreign investment decisions. Identify these problems.

Refer from in problem 1.

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:

 

Refer from in problem 2.

The Wayne Company currently exports 500 calculators per month to Jordan at a price of

\($60\) and the variable cost per calculator is \($40.\) In May 1990, the company is approached by the government of Jordan with a request that it establish a small manufacturing plant in Jordan. After a careful analysis, the company decides to make an equity investment of

\($1\) million, half of which will represent working capital and the other half-fixed assets. The company will sell the plant to a local investor for the sum of \($1\) at the end of 5 years and the central bank of Jordan will repay the company for the working capital of \($500,000.\) In return for an increase in tariffs against other companies, the Wayne Company is willing to sell its calculators in Jordan for \($50\) per unit. In addition, the company will have to buy certain raw materials from local suppliers and will have to use local managers. The total costs of the local managers and materials will be \($15\) per calculator. Other materials will be purchased from the parent at \($10\) per unit and the parent will receive a direct contribution to overhead after variable costs of \($5\) per unit sold. Under this arrangement, the company expects that it will sell 1,000 calculators per month. The fixed assets are to be depreciated on a straight-line basis over a 5-year period. The company will have to pay income taxes at 50 percent on profits earned in Jordan. The USA also has a 50 percent tax rate with direct credit for Jordanian taxes. The current exchange rate is 10 Jordanian dinars per dollar and it is expected to stay the same for the next 5 years. There is no restriction on cash flow repatriation.

 

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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