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New Zealand but is considering on in New Zealand dollars (NZS). Wolverine Corp. currently has no existing business in New Zealand but is consi establishing a subsidiary there. The following information has been gathered to this project: The initial investment required is NZ$50 million in New Zealand dollars Given the existing spot rate of $.50 per New Zealand dollar, the initial invest in U.S. dollars is $25 million. In addition to the NZ$50 million initial investmen for plant and equipment. NZ$20 million is needed for working capital and will be borrowed by the subsidiary from a New Zealand bank. The New Zealand subsidiary will pay interest only on the loan each year, at an interest rate of 14 percent. The loan principal is to be paid in 10 years. The project will be terminated at the end of Year 3, when the subsidiary will be sold. The price, demand, and variable cost of the product in New Zealand are as follows: Year Price NZ$500 NZ$511 NZ$530 Demand 40,000 units 50,000 units 60,000 units Variable Cost NZ$30 NZ$35 NZ$40 The fixed costs, such as overhead expenses, are estimated to be NZ$6 million per year. The exchange rate of the New Zealand dollar is expected to be $.52 at the end of Year 1, $.54 at the end of Year 2, and $.56 at the end of Year 3. The New Zealand government will impose an income tax of 30 percent on income. In addition, it will impose a withholding tax of 10 percent on earnings remitted by the subsidiary. The U.S. government will allow a tax credit on the remitted earnings and will not impose any additional taxes. All cash flows received by the subsidiary are to be sent to the parent at the end of each year. The subsidiary will use its working capital to support ongoing operations. The plant and equipment are depreciated over 10 years using the straight-line depreciation method. Since the plant and equipment are initially valued at NZS50 million, the annual depreciation expense is NZ$5 million. In three years, the subsidiary is to be sold. Wolverine plans to let the acquiring firm assume the existing New Zealand loan. The working capital will no it sells the subsidiary. liquidated but will be used by the acquiring firm when it sells the sub Wolverine expects to receive NZ$52 million after subtracting capital gains tax Assume that this amount is not subject to a withholding tax. Wolverine requires a 20 percent rate of return on this project a. Determine the net present value of this project. Should Wolverine accept this project? b. Assume that Wolverine is also considering an alternative financing arrangement in which the parent would invest an additional US$10 million (20 million NZD) cover the working capital requirements so that the subsidiary would avoid the New Zealand loan (the upfront investment is now 50 million NZD plus 20 million NZD for the Net Working Capital resulting in a total investment of 70 million NZD). If this arrangement is used, the selling price of the subsidiary after subtracting any canital gains taxes) is expected to be NZ$18 million higher. Is this alternative financing arrangement more feasible for the parent than the original proposal? Explain! From the parent's perspective, would the NPV of this project be more sensitive to exchange rate movements if the subsidiary uses New Zealand financing to cover the working capital or if the parent invests more of its own funds to cover the working capital? Explain. d. Assume Wolverine used the original financing proposal and that funds are blocked until the subsidiary is sold. The funds to be remitted are reinvested at a rate of 6 percent after taxes) until the end of Year 3. How is the project's NPV affected? e. What is the break-even salvage value of this project if Wolverine uses the original financing proposal and funds are not blocked? 2) By what percent can Unit Sales (Demand) decrease and the project breakeven on NPV (use the original proposal)? 3) By what percent can Fixed Costs increase and the project breakeven on NPV (use the original proposal)? 4) Assume a bad case scenario has happened (prices will be 5% less than forecasted, demand will be 10% less than forecasted, and fixed costs will be 10% more than forecasted). What is the NP under this scenario
