3)RSE, Inc. is a US producer of recreational sports equipment. Suppose that you, as the CFO of RSE, Inc, Inc., believe the growth potential for some of sports equipment, particularly tennis and squash rackets, in Thailand is very high. The firm is currently exporting products to Thailand. Given the expectations for high growth, however, you, together with the Board of Directors, are considering establishing a subsidiary in Thailand. RSE, Inc has been exporting products to Thailand, and its international division believes there is sufficient demand for the product, and that a Thai investment may be appropriate at this time. The time horizon for the investment is 10 years (that is, 10 years of operating income). Your job is to decide whether the investment is worthwhile. Below are the details you need to make your decision [note: TB=Thai Baht]: a) The Thai economy is expected to expand in the next few years. Thai inflation is projected to be 4.5% annually, and US inflation is expected to be 2% annually. The current exchange rate (in Year 0 of the project) is Thai Baht 30/$, and the firm assumes that Relative Purchasing Power Parity (Relative PPP) holds over the period of the project. b) The initial investment i) The required investment in fixed assets today is Thai baht 100 million (i.e. at time t=0). These fixed assets will be depreciated on a straight-line basis over the 10 years of the projects projected life. ii) The subsidiary will be set up on government-owned land that will be sold to RSE, Inc. for TB 30 million today (at time t=0). c) Sales Volume i) Sales volume for the first year (year 1) is estimated to be 40,000 units. RSE, Inc expects the sales volume to increase by 10% per year for the remainder of the project (i.e. in years 2-10). ii) The Selling price per unit sold in the first year will be TB 1500 per unit. The firm then expects the per unit price to rise at an annual rate of 5% over the life of the project. d) Cost of Goods Sold i) Local materials and labor costs per unit are expected to be TB 400 per unit in the first year of operation (Year 1), and the per unit costs are expected to rise by 5% per year thereafter. ii) Manufacturing overhead (without depreciation) is expected to be TB 2 million the first year of operation (year 1). The firm expects this cost to rise by 3% per year. e) Selling and Administrative costs i) The variable portion of selling and administrative costs each year are expected to equal 10% of that years annual sales revenue. ii) Semi-fixed selling costs are expected to be equal to 5% of the first years sales. These costs will then rise at a 3% annual rate (using the year 1 semi-fixed costs as the base year costs). f) Licensing fees i) The parent company will levy a TB 115 per unit licensing fees in the first year of operations (year 1), payable at the end of the year in US dollars. ii) This license fee will increase 5% per year to compensate for Thai inflation. g) Interest Expense The firm can borrow in the short-term Thai debt market. Assume the interest cost on the debt is Thai 0.5 million per year in the first three years of operations, and zero after that time. h) Working Capital Assume that the companys net working capital requirements each year in years 0-9 are equal to 30% of the expected revenue in the following year [e.g. NWC investment in year 0 = 0.3* (Year 1 Revenue)]. Assume also that any investments in net working capital are recaptured in year 10 (at the end of the project). i) Terminal value Suppose RSE, Inc. believes the total terminal value of the subsidiary is computed as equal to the sum of the year 10 market value of the land (=TB 50 million), the salvage value of the fixed assets in year 10 (=TB 250 million), and the amount of the recapture of the investment in net working capital (calculate this based on the investments in NWC in years 0-9). Taxes on the terminal value: Assume the differences between the terminal and initial land and fixed asset values are taxed at the capital gains tax rate. (Net working capital recapture is not taxed). j) Tax rates Corporate income tax and capital gains tax rates in Thailand are 20%. The Thai government also assesses withholding taxes on licensing fees paid to foreign companies at a rate of 15%. The parent companys US capital gains and income tax rates are 30%. Assume also the parent company can take appropriate credits for taxes paid to, or withheld by, the Thai government. . k) Exports lost: RSE, Inc presently exports about 10,000 units per year to Thailand. If RSE, Inc decides to establish the Thai subsidiary, it is expected that the before-tax EBIT from the lost export sales (in US dollar terms) will be $600,000, $650,000, and $700,000 in the first 3 years of operation, respectively. RSE, Inc assumes it cannot count on these export sales for more than 3 years because the Thai government is encouraging local production of consumer items. k) Assume the parent firms WACC in $ terms is 16%.

Answer the Following:

A. (22 points) What is the NPV of the subsidiarys cash flows from the projects viewpoint [that is, use the standard npv approach to answer this question]? What is the NPV from the parents viewpoint? Should RSE, Inc build the subsidiary? Show your calculations in an Excel Spreadsheet & Discuss.