CASE: National Motors CAR PRODUCTION PROJECT

AUS car manufacturing company, National Motors is considering building a new project in the UK to produce Sting sports cars. Construction costs are expected to be 50,000,000 and construction will be completed within a year. The plant will increase debt capacity by approximately $40,000,000. National Motors has the ability to reinvest the 20,000,000 it owns in the UK. If this capital is transferred to the US, it will be subject to an effective tax rate of 46%. Inflation in the UK is expected to be 15%, in the US it is 10%. The current spot rate is S0 of 2$/ and the company expects that purchasing power parity will exist. National Motors plans to sell the Sting with moderate improvements for five years and after this period the factory will implement a new model. The value of the plant for future use is expected to be 40,000,000 on nominal terms after five years. The Sting will have a starting price of 8,000 and is expected to sell 10,000 cars a year. Production costs are expected to be 6,000. These values are expected to change with the general price level in the UK. Revenues and costs are estimated at the beginning of plant construction.

National Motors also produces a 2-seat car in Switzerland called the Racer and plans to replace 2,000 Racer cars with the Sting. The expected after-tax profit on Racer cars at the time of starting construction of the Sting car factory is SFr 5,000/vehicle, with an exchange rate of SFr 4/. This rate changes with inflation in Switzerland and purchasing power parity is expected to prevail in the UK and Switzerland. Because National Motors was going to build the Sting factory in Merseyside, an area with high unemployment, the British government gave the company a loan of 20,000,000 at 10% interest. The principal will be repaid equally each year for five years with payments beginning in the first year of production. The market interest rate in the UK is 20%/year while in the US the borrowing interest rate is 12% and the risk-free interest rate is 10%. The balance of capital will be financed by equity capital. The tax rate in the UK is 50% higher than the tax rate of 46% in the US. Tax law in the UK allows car factories to be depreciated over 5 years. Tax authorities in the UK and US consider fair transfer pricing very carefully so that internal transfer pricing techniques do not deliver tax savings. National Motors believes that a discount rate of 20% is appropriate for the project.

Should we build a Sting car factory?