Multinational Capital Budgeting

Xpress Tel is planning on investing US $40 million in Belarus this year for network communications systems to generate new business over the next three years,

• In addition to the initial investment for plant and equipment, 10 million Belarusian rubles (BYN) is needed for working capital and will be borrowed by the subsidiary from a Belarusian bank. The Belarus subsidiary will pay interest only on the loan each year, at an interest rate of 11 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.
• Initial price in year 1 is set at BYN 350 with variable cost of BYN 120. The price and variable cost of the product are expected to increase at the Belarus inflation rate.
• Demand for the product is expected at 120,000 units in the first year and expected to grow at 20%.
• The fixed costs, such as overhead expenses, are estimated to be BYN 3.5 million per year and will grow at 10%.
• The Belarus government will impose an income tax of 35% on income. Plus, the Belarus capital gains tax rate is 20%.In addition, it will impose a withholding tax of 10% on earnings remitted by the subsidiary. The U.S. government 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.
• In three years, the subsidiary is to be sold. Xpress plans to let the acquiring firm assume the existing Belarusian loan.
• The working capital will not be liquidated but will be used by the acquiring firm when it sells the subsidiary. Xpress expects to receive BYN 70 million before taxes. Assume that this amount is not subject to withholding tax, but is subject to capital gains tax.
• The Belarus current and expected inflation rate is 5.2% per annum over this period and the U.S. inflation rate is expected to be 2.8% per annum.
• The current exchange rate is US$.5/BYN.
• Xpress has a WACC of 14% and will add 100 basis points for the Belarus project due to additional country risk

3. Assume that Xpress is also considering an alternative financing arrangement, in which the parent would invest an additional US$5 million to cover the working capital requirements so that the subsidiary would avoid the Belarusianloan. If this arrangement is used, the selling price of the subsidiary is expected to be BYN 10 million higher. Is this alternative financing arrangement more feasible for the parent than the original proposal? Assume that the PPP holds

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\begin{tabular}{|c|c|c|c|c|c|} \hline \multicolumn{6}{|l|}{iii.XpressTel} \\ \hline \multicolumn{6}{|l|}{ iii. } \\ \hline Initial price & 350 & per unit in BYN & & & \\ \hline Initial variable costs & 120 & per unit in BYN & & & \\ \hline Initial sales units & 120,000 & & & & \\ \hline Initial fixed costs & 3,500,000 & in BYN & & & \\ \hline Initial investment & 40,000,000 & in USD & & & \\ \hline Salvage value & 80,000,000 & in BYN & & & \\ \hline Interest & 11% & & & & \\ \hline Belarustax rate & 35.0% & & & & \\ \hline Withholding tax rate & 10.0% & & & & \\ \hline Belarus cap. gains tax rate & 20.0% & & & & \\ \hline WACC & 15.0% & & & & \\ \hline Sales units growth & 20.0% & & & & \\ \hline FC growth & 10.0% & & & & \\ \hline Price/Vc growth & 5.2% & & & & \\ \hline Working capital & 5,000,000 & in USD & & & \\ \hline Project life & 3 & yrs & & & \\ \hline \multicolumn{6}{|l|}{ Exchange Rate Forecast } \\ \hline US Inflation Forecast & 2.80% & & & & \\ \hline Belarus Inflation Forecast & 5.20% & & & & \\ \hline ppp (Chg of Value of Foreign Currency) & -0.02281369 & & & & \\ \hline Year & 0 & 1 & 2 & 3 & \\ \hline Exchange Rates & 0.50000000 & 0.48859316 & 0.47744654 & 0.46655423 & $/BYN \\ \hline Year & 0 & 1 & 2 & 3 & Remaining years \\ \hline Sales units & & 120,000 & 144,000 & 172,800 & \\ \hline Price per unit & & 350.00 & 368.20 & 387.35 & \\ \hline VC per unit & & 120.00 & 126.24 & 132.80 & \\ \hline Straight Line Depreciation ( % ) & & 10.00% & 10.00% & 10.00% & 70.00% \\ \hline \multicolumn{6}{|l|}{ Projections (Belarusian ruble) } \\ \hline Revenue & & 42,000,000.00 & 53,020,800.00 & 66,933,457.92 & \\ \hline Variable costs & & 14,400,000.00 & 18,178,560.00 & 22,948,614.14 & \\ \hline Fbxed costs & & 3,500,000.00 & 3,850,000.00 & 4,235,000,00 & \\ \hline \multicolumn{6}{|l|}{ Interest payments } \\ \hline Depreciation & & 8,000,000.00 & 8,000,000.00 & 8,000,000.00 & \\ \hline Pretax profit & & 16,100,000.00 & 22,992,240.00 & 31,749,843.78 & \\ \hline Tax & & 5,635,000.00 & 8,047,284.00 & 11,112,445.32 & \\ \hline Net income & & 10,465,000.00 & 14,944,956.00 & 20,637,398.45 & \\ \hline CF from operations - Subsidiary & & 18,465,000.00 & 22,944,956.00 & 28,637,398.45 & \\ \hline Withholding taxes & & 1,846,500.00 & 2,294,495.60 & 2,863,739.85 & \\ \hline BYII remitted after withholding taxes & & 16,618,500.00 & 20,650,460.40 & 25,773,658.61 & \\ \hline CF from Salvage value & & & & 75,200,000.00 & = \\ \hline After taxCF remitted & & 16,618,500.00 & 20,650,460.40 & 100,973,658.61 & \\ \hline \multicolumn{6}{|l|}{ Projections (US \$) } \\ \hline Exchange Rate Scenario \#1 & 0.500000 & 0.488593 & 0.477447 & 0.466554 & $/BYN \\ \hline Cash flows to parent & & S 8,119,685.36 & S 9,859,490.95 & S 47,109,687.28 & \\ \hline CF from working capital & S (5,000,000.00) & & & & \\ \hline CF from capital investments & S(40,000,000.00) & & & & \\ \hline Total CF & $(45,000,000.00) & $8,119,685.36 & S 9,859,490.95 & \$ 47,109,687.28 & \\ \hline NPV - Expected & $491,171.70 & & & & \\ \hline IRR & 15.4956% & & & & \\ \hline \multicolumn{6}{|c|}{ * After-tax salvage value from subsidiary sales (BYII) } \\ \hline Initial Investment & 80,000,000 & & & & \\ \hline Cumulative Depreciation (Yr3) & 24,000,000 & & & & \\ \hline End Book Value (Yr3) & 56,000,000 & & & & \\ \hline Sale Price in Yr3 & 80,000,000 & & & & \\ \hline Capital Gains & 24,000,000 & & & & \\ \hline Taxes on Cap. Gain & 4,800,000 & & & & \\ \hline After tax cash flow & 75,200,000 & & & & \\ \hline \end{tabular}