A multinational company is currently exporting to country X. Sales in X for years 1-4 are estimated at 100m per year. Production costs of the goods sold in country X for the same period are 50m per year. Transportation costs for the same period are estimated at 40m per year. The company is currently considering whether to open a subsidiary in country X as a way to partially relocate production to the country. This would leave sales and production costs unchanged but would cut transportation costs by 50%. Setting up the subsidiary would require an investment of 60m in year 0, none of which is expected to be recovered. The investment would be half financed by equity and half by debt. Assume that the production line will become obsolete after year 4, that the multinational has a debt to equity ratio equal to one and an equity beta equal to 2, that the market risk premium is 4%, that the risk free rate is 2%, and that the company can issue risk free debt. Finally, assume no taxes.

a. Should the company set up the subsidiary? Give reasons for your answer.

b. Suppose you were told that the subsidiary will be 100% equity financed (but the multinational still has a debt to equity ratio equal to one and the beta of debt is zero). What would be the appropriate discount rate for this project? Give reasons for your answer.

c. The value of the inventory needed for the existing operations of the multinational is estimated to be 100m in year 0, 200m in year 1, 300m in year 2, 400 in year 3 and 0 in year 4. Suppose that the subsidiarys operations would require the multinational to increase the amount of some components of the final product in its inventory. This would increase the inventory by 10% per year for the next 4 years. Should the company set up the subsidiary