Capital Budgeting Analysis. After three years successful operation in Mexico, your company is considering to expand your ESL business to other non-U.S. countries where some individuals may want to learn American style English. From John's recent trip to East Asia, China, South Korea and Japan, he is considering China and ask you to perform financial feasibility analysis and report to the board meeting for discussion. You did some research on China, you found that China is not favorably ranked on its business environment per http://www.doingbusiness.org/rankings but its economy grow still posts good growth rate per another market potential ranking http://globaledge.msu.edu/mpi. After your research you gathered following information to assess this project. Your recent qualitative PEST (Political/legal, Economic/financial, Social/cultural, and Technologic analysis) analysis has well received by the board, you were asked to conduct a quantitative financial feasibility analysis to support financial (capital budgeting) feasibility analysis.

? The initial investment required is 8 million in Chinese Yuan (RMB). Given the existing spot rate of $.15 per RMB, the initial investment in U.S. dollars is $1.2 million. In addition to the initial investment for building the language lab, $0.5 million is needed for working capital and will be borrowed by the subsidiary from a local Chinese bank. The Chinese subsidiary will pay interest on the loan each year, at an interest rate of 5% which is approximately RMB 166,700 per year. The loan principal is to be paid in the 10th years.

? Assume the project be terminated at the end of Year 5, when the subsidiary will be sold.

? The tuition price (4 weeks module), demand (one student per module = one unit), and variable cost of the service in China are as follows: 6 weeks course module RMB 1800 per student. Tuition price & variable cost increase at 6% a year due to inflation and demand increases at 7.5% after year one percent higher with GDP growth projection of the country.

\fyear 0 year 1 year 2 year 3 year 4 year 5 Subsidiary perspective 1 Demand 4000 4300 4622.5 4969.19 5341.88 2 Price per unit 1800 1908 2022.48 2143.83 2272.46 3 Total revenue=(1)x(2) 7200000 8204400 9348914 10653099 12139209 5 Variable cost per unit 150 159 168.54 178.65 189.37 6 Total variable cost=(1)x(5) 500000 683700 779076.2 887745.79 1011591.8 7 Interest payment on RMB loan 166,700 166,700 166,700 166,700 166,700 8 Fixed cost 400,000 400,000 400,000 400,000 400,000 9 Depreciation 800,000 800,000 800,000 800,000 800,000 10 Total expenses=(6)+(7)+(8)+(9) 1,966,700 2,050,400 2,145,776 2,254,446 2,378,292 11 12 Subsidiary earning before tax=(3)-(10) 5,233,300 6,154,000 7,203,138 8,398,653 9,760,917 13 Host government tax 20% 1046660 1230800 1440628 1679730.6 1952183.4 14 Subsidiary earning after tax=(12)-(13) 4,186,640 4,923,200 5,762,510 6,718,922 7,808,733 15 Subsidiary net cashflow=(14)+(9) 4,986,640 5,723,200 6,562,510 7,518,922 8,608,733 16 RMB remitted by subsidiary =100% of (15) 7,518,922 8,608,733 17 Host government withholding tax 15% 1291310 18 RMB remitted after withholding tax=(16)-(17) 19 Salvage value 20 Parent perspective 21 Exchange rate US$ price per RMB 22 Cash flow to parent in US$=[(18)+(19)]x(21) 23 PV of Parent cash inflow 24 Initial investment in US$ -1,200,000 25 Cumulative NPV of cashflowsProbability Inflation Exchange Rate Scenario Demand Scenario % change per year % per year % per year against USD 50% 2 4 50% 10 10 -4 -5