Question
Blue Heaven, a Canadian company, is thinking of establishing a subsidiary in the UAE, which requires an initial investment of 60 million UAE dirham. The
Blue Heaven, a Canadian company, is thinking of establishing a subsidiary in the UAE, which requires an initial investment of 60 million UAE dirham. The relevant information is below to evaluate this project. It currently takes 2.85 UAE dirham to buy one Canadian dollar, and the dirham is expected to remain constant in value over the next two years, and then appreciate by 5% in the next year thereafter. The subsidiary will be sold at the end of Year 3, which is when the project will be terminated. Sales price, consumer demand and variable cost of the product in the UAE are below. Year Sales Price per unit (in AED) Demand Variable Cost per unit (in AED) 1 340 50,000 units 100 2 420 65,000 units 150 3 510 75,000 units 180 Estimated fixed costs are AED 6 million per year. 25% tax on before-tax earnings will be imposed by the UAE government. In addition, there will be a withholding tax of 10% on funds remitted overseas by the subsidiary. The UAE subsidiary will remit 100% of net cash flows to the parent at the end of each year. Plant and equipment will be depreciated using the straight-line depreciation method, with an annual depreciation expense of AED 3 million for each of the three years. Blue Heaven intends to sell the subsidiary in three years. The salvage value is AED 40 million. The required rate of return on this project is 16%. Required: 1) Calculate the net present value (NPV) of this project. 2) How would your answer change if the value of the UAE dirham were expected remain unchanged from its current value of 2.85 UAE dirham per Canadian dollar over the course of the three years?
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