An Italian Company Is Considering Expanding The Sales Of Its Cappuccino Machines

An Italian company is considering expanding the sales of its cappuccino

machines to the U.S market. As a result, the idea of a setting up a manufacturing facility in the U.S should be explored. The company estimates the initial demand

in U.S 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 on its U.S. export. 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 10 million 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 will allow the company to straight-line depreciates the new facility over a 5-year period. After

that time, the company plans to sell all molding equipment (accounts for 50% of the project's cost). Although it is difficult to estimate the salvage value, the

company is confident that the after-tax salvage value will be at least 25% of the original book value. Corporate tax rates in the U.S and Italy are the same as 35%.

The lonq-term inflation rate is expected to be 3% in the U.S and 5% in Italy. The current spot exchange rate is $ 1.5/. The Italian company explicitly believes in

PPP as the best means to forecast future exchange rate. The company's U.S 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 estimates its weighted

average cost of capital to be 11%, and all-equity cost of capital to be 15%. It can borrow dollars at 9% per annum and Euros at 10%.

2) Calculate the benefit of using concessionary loan.