An Italian company is considering expanding the sales of its cappuccino machines to the US market. As a result, the sides of a setting up a manufacturing facility in the US, should be explored. The company estimates the initial demand in US will bring in an annual operating profit of $2,500,000, which is expected to keep track with the U.S. price level. The new facility will free up the amount currently exported to the U.S. market. The company presently realizes an annual operating profit of 1,000,000 Euro on US export, which keeps track with the price level in Italy. 

The manufacturing facility is expected to cost $24 million. The company plans to finance the project with a combination of debt and equity capital. The new project will increase the company's borrowing capacity by 10M Euro, and the company plans to borrow only that amount. The city in which the facility will be built has promised to provide a 5-year loan of $7.5 million at 6% per annum.

The U.S. IRS allows the company to straight-line depreciate the new facility over a 5-year period. After that time, the company plans to terminate the project and sell all molding equipment, which accounts for 50% of the project cost. The company estimates that the after tax salvage value of molding equipment will be no more than 25% of its original book value.

Corporate tax rates in the US and Italy are the same as 35%. The long-term inflation rate is expected to be 3% in the US, and 5% in Italy. The current spot exchange rate is $1.5/Euro. The Italian company explicitly believes in PPP as the best means to forecast future exchange rate.

The company's US. Sales affiliate currently holds $1.5 million ready for repatriation back to Italy The money was accumulated under a special tax concession rate of 25% If the fund were repatriated, additional tax will be due.

 The company's weighted average cost of capital is 11%, cost of dollar borrowing us 9%, cost of Euro borrowing is 10%, and cost of equity is 18%. The all-equity Euro cost of capital is 15%.

 

Discuss the financing of the project, including the amount of borrowing and borrowing cost?