Acme Corporation, a U.S. company based in Truth or Consequences, New Mexico, is considering establishing a wholly owned sales subsidiary in Ambrosia to distribute Acmes U.S.-made high-tech products throughout Eurasia. If Acme establishes an Ambrosian sales subsidiary, Acme management expects that fifteen percent of that subsidiarys sales and income will be to non-Ambrosian customers throughout Eurasia, and that eighty-five percent of sales and income will be to customers located in Ambrosia.

Initial investment and financing: Acmes initial investment in the Ambrosian subsidiary would consist of an equity investment of 41,000,000 Ambrosian kroon. The subsidiary would also obtain a three-year 10,000,000-kroon loan from a local bank at an interest rate of 10 percent per year.

Inflation and exchange rates: Economists at the International Monetary Fund and at the World Bank expect that inflation in Ambrosia will be 10 percent per year over the next three years. As a result, economists expect that the Ambrosian kroon will depreciate 10 percent per year relative to the U.S. dollar. The January 1, Year 1 exchange rate is $0.90 per kroon. Forecasted exchange rates over the next three years are as follows:

January 1, Year 1 $0.900 per kroon

Average for Year 1 $0.855 per kroon

December 31, Year 1 $0.810 per kroon

Average for Year 2 $0.770 per kroon

December 31, Year 2 $0.729 per kroon

Average for Year 3 $0.695 per kroon

December 31, Year 3 $0.660 per kroon

Taxes: The Ambrosian corporate income tax rate is 20 percent. The proposed Ambrosian subsidiary would have to pay taxes on December 31 of each year. Additionally, Ambrosia imposes a 10 percent withholding tax on dividends on the calendar date of distribution of dividends to a foreign parent company. The U.S. corporate tax rate is 21 percent.

Political risk: Moodys Investors Service has assigned Ambrosia a sovereign credit rating of Aa3, indicating that Moodys deems Ambrosias debt obligations to be of high quality and subject to very low credit risk. Acme management believes that the risk of nationalization of Ambrosian private sector industries is negligible (i.e., small enough to be tantamount to zero).

Terminal value: In evaluating potential investment projects for economic viability, Acme management makes cash flow forecasts for three years. If Acme were to establish an Ambrosian sales subsidiary, management would expect that the terminal value at the end of three years will be equal to the present value of an infinite stream of third-year cash flow from operations (CFO) (i.e., CFO in Year 3 divided by the weighted-average cost of capital).

Dividends and repatriation restrictions: Ambrosia allows businesses located within the country to remit up to 50 percent of after-tax accounting income as dividends to foreign parent corporations. Acme management would require that the Ambrosian subsidiary remit 50 percent of its after-tax income as dividends to Acme. The Ambrosian subsidiary would remit dividends to Acme on December 31 of each year.

Weighted-average cost of capital: Acmes weighted-average cost of capital is 17 percent. In Ambrosia, corporate managers generally expect that investment projects will earn an after-tax return of 17 percent.

Present value factors:

Year	Factor
1	0.85470
2	0.73051
3	0.62437

Forecasted earnings: Acme has prepared the following forecast of after-tax earnings for the proposed investment in, and establishment of, an Ambrosian sales subsidiary:

Forecasted Earnings of Proposed Ambrosian Sales Subsidiary

(Amounts in Ambrosian kroon)

	Year 1	Year 2	Year 3
Sales	25,200,000	29,232,000	33,909,120
Cost of goods sold	12,600,000	14,031,360	16,276,378
Selling, general, and administrative expenses	1,000,000	1,150,000	1,311,000
Depreciation expense	7,000,000	7,000,000	7,000,000
Interest expense	1,000,000	1,000,000	1,000,000
Other operating expenses	500,000	585,000	684,450
Income before income tax	3,100,000	5,465,640	7,637,292
Income tax expense	620,000	1,093,128	1,527,458
Net income	2,480,000	4,372,512	6,109,834

Required:

Determine the net present value of Acmes potential Ambrosian investment from: (1) a project perspective and (2) a parent company perspective. Should Acme make the investment? Why or why not?