Because Ben Holt, Bladeschief financial officer,believes the growth potential for the roller blade marketin Thailand is very high, he has decided to invest inThailand. The investment would involve establishinga subsidiary in Bangkok consisting of a manufacturingplant to produce Speedos, Bladeshigh-quality rollerblades. Holt believes that economic conditions in Thai-land will be relatively strong in 10 years, when heexpects to sell the subsidiary.Blades will continue exporting to the United King-dom under an existing agreement with Jogs, Ltd., aBritish retailer. Furthermore, it will continue itssales in the United States. Under an existing agree-ment with Entertainment Products, Inc., a Thairetailer, Blades is committed to selling 180,000 pairsof Speedos to the retailer at a fixed price of 4,594 Thaibaht per pair. Once operations in Thailand com-mence, the agreement will last another year, atwhich time it may be renewed. Thus, during its firstyear of operations in Thailand, Blades will sell180,000 pairs of roller blades to Entertainment Pro-ducts under the existing agreement whether it hasoperations in the country or not. If it establishes theplant in Thailand, Blades will produce 108,000 of the180,000 Entertainment Products Speedos at the plantduring the last year of the agreement. Therefore, thenew subsidiary would need to import 72,000 pairs ofSpeedos from the United States so that it can accom-modate its agreement with Entertainment Products.It will save the equivalent of 300 baht per pair invariable costs on the 108,000 pairs not previouslymanufactured in Thailand.Entertainment Products has already declared itswillingness to renew the agreement for another threeyears under identical terms. Because of recent deliverydelays, however, it is willing to renew the agreementonly if Blades has operations in Thailand. Moreover,if Blades has a subsidiary in Thailand, EntertainmentProducts will keep renewing the existing agreement aslong as Blades operates in Thailand. If the agreement isrenewed, Blades expects to sell a total of 300,000 pairsof Speedos annually during its first two years of opera-tion in Thailand to various retailers, including 180,000pairs to Entertainment Products. After this time, itexpects to sell 400,000 pairs annually (including180,000 to Entertainment Products). If the agreementis not renewed, Blades will be able to sell only 5,000pairs to Entertainment Products annually but not at afixed price. Thus if the agreement is not renewed,Blades expects to sell a total of 125,000 pairs of Speedosannually during its first two years of operation in Thai-land and 225,000 pairs annually thereafter. Pairs notsold under the contractual agreement with Entertain-ment Products will be sold for 5,000 Thai baht per pair,because Entertainment Products had required a lowerprice to compensate it for the risk of being unable tosell the pairs it purchased from Blades.Holt wishes to analyze the financial feasibility ofestablishing a subsidiary in Thailand. As a Bladesfinancial analyst, you have been given the task of ana-lyzing the proposed project. Because future economicconditions in Thailand are highly uncertain, Holt hasalso asked you to conduct some sensitivity analyses.Fortunately, he has provided most of the information

you need to conduct a capital budgeting analysis. Thisinformation is detailed here:The building and equipment needed will cost 550million Thai baht. This amount includes additionalfunds to support working capital.The plant and equipment, valued at 300 millionbaht, will be depreciated using straight-line depreci-ation. Thus 30 million baht will be depreciatedannually for 10 years.The variable costs needed to manufacture Speedosare estimated to be 3,500 baht per pair next year.Bladesfixed operating expenses, such as adminis-trative salaries, will be 25 million baht next year.The current spot exchange rate of the Thai baht is $.023. Blades expects the baht to depreciate by anaverage of 2 percent per year for the next 10 years.The Thai government will impose a 25 percent taxrate on income and a 10 percent withholding tax onany funds remitted by the subsidiary to Blades. Anyearnings remitted to the United States will not betaxed again.After 10 years, Blades expects to sell its Thai subsidi-ary. It expects to sell the subsidiary for about 650 mil-lion baht, after considering any capital gains taxes.The average annual inflation in Thailand is expectedto be 12 percent. Unless prices are contractuallyfixed, revenue, variable costs, and fixed costs aresubject to inflation and are expected to change bythe same annual rate as the inflation rate.Blades could continue its current operations ofexporting to and importing from Thailand, whichhave generated a return of about 20 percent. Bladesrequires a return of 25 percent on this project inorder to justify its investment in Thailand. All excessfunds generated by the Thai subsidiary will be remittedto Blades and will be used to support U.S. operations.Holt has asked you to answer the followingquestions:1.Should the sales and the associated costs of 180,000pairs of roller blades to be sold in Thailand under theexisting agreement be included in the capital budgetinganalysis to decide whether Blades should establish asubsidiary in Thailand? Should the sales resulting froma renewed agreement be included? Why or why not?2.Using a spreadsheet, conduct a capital budgetinganalysis for the proposed project, assuming that Bladesrenews the agreement with Entertainment Products.Should Blades establish a subsidiary in Thailand underthese conditions?3.Using a spreadsheet, conduct a capital budgetinganalysis for the proposed project assuming that Bladesdoes not renew the agreement with EntertainmentProducts. Should Blades establish a subsidiary inThailand under these conditions? Should Blades renewthe agreement with Entertainment Products?4.Because future economic conditions in Thailand areuncertain, Holt would like to know how critical the sal-vage value is in the alternative you think is most feasible.5.The future value of the baht is highly uncertain.Under a worst-case scenario, the baht may depreciate byas much as 5 percent annually. Revise your spreadsheet toillustrate how this would affect Bladesdecision to estab-lish a subsidiary in Thailand. (Use the capital budgetinganalysis you have identified as the most favorable fromquestions 2 and 3 to answer this question.)

2.Using a spreadsheet, conduct a capital budgetinganalysis for the proposed project, assuming that Bladesrenews the agreement with Entertainment Products.Should Blades establish a subsidiary in Thailand underthese conditions?