International Capital Budgeting (16 point)

FMC Inc. is a U.S. manufacturing company. It is considering an investment in a plant in France, a market which has up to now been served by exports from U.S. plants. The international finance group of FMC has projected sales, after-tax profits (in France), and the exchange rate for the proposed French plant for the next 5 years as follows:

Year Sales Operating Expenses Exchange Rate ($/euro)

0 $1.10

1 30 mil 12 mil $1.05

2 40 16 $1.00

3 50 20 $0.95

4 60 24 $0.90

5 70 28 $0.85

The U.S. parent would make an initial investment of 60 mil to build and equip the plant. The firm anticipates that they will sell the plant at the end of the five years for 10 mil. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, which is equivalent to 12 mil/year. The French tax rate is 40%. Assume that all free cash flows will be repatriated to the parent. FMC uses a cost of capital of 20% on investments of this nature.

1) Do a NPV and IRR analysis from the parent viewpoint to decide whether the project should be accepted or not.

2) How would your answer change if Euro depreciates by 5% every year? Compare (1) and (2) and discuss the impact of a weaker Euro on the NPV of the project.

3) In order to reduce the exchange rate exposure, FMC uses forward contract to hedge 15 million euro every year. The one-year through five-year forward rate is the same as $1.03. Assume Euro depreciates by 5% in the spot market every year, what is the new NPV after hedging? Compare (2) and (3) and discuss the benefits of hedging.

4) Assume that funds are blocked until the subsidiary is sold. The funds to be remitted are reinvested at a rate of 8 percent (after taxes) until the end of Year 3. How is the project NPV affected? Assume euro depreciates by 5% in the spot market every year. Compare (1) and (4), discuss the impact of block funds.