North Star Company will go forward with its intentions to build the subsidiary only if it expects to achieve a return on its capital of 18 percent or more.

North Star is considering an alternative financing arrangement. With this arrange- ment, the parent would provide $10 million (S$20 million), which means that the sub- sidiary would need to borrow S$20 million. Under this scenario, the subsidiary would obtain a 20-year loan and pay interest on the loan each year. The interest payments are S$1.6 million per year. In addition, the forecasted proceeds to be received from selling the subsidiary (after taxes) at the end of 6 years would be S$20 million (the forecast of proceeds is revised downward here because the equity investment of the subsidiary is less; the buyer would be assuming more debt if part of the initial investment in the sub- sidiary were supported by local bank loans). Assume that the parents required rate of return would still be 18 percent.

a. Which of the two financing arrangements would you recommend for the parent? Assess the forecasted NPV for each exchange rate scenario to compare the two financing arrangements and substantiate your recommendation.

b. In the first question, an alternative arrangement of partial financing by the sub- sidiary was considered while assuming that the required rate of return by the parent would not be affected. Is there any reason why the parents required rate of return might increase when using this financing arrangement? Explain. How would you revise the analysis in the previous question under this situation? (This question requires discussion, not analysis.)

c. Would you recommend that North Star Company establish the subsidiary even if the withholding tax is 20 percent?

d. Assume that there is some concern about the economic conditions in Singapore that could reduce net cash flows to the subsidiary. Explain how Excel could be used to reevaluate the project based on alternative cash flow scenarios. That is, how can this form of country risk be incorporated into the capital budgeting decision? (This question requires discussion, not analysis.)

e. Assume that North Star Company does implement the project, investing $10 million of its own funds with the remainder borrowed by the subsidiary. Two years later, a U.S.-based corporation notifies North Star that it would like to purchase the subsidiary. Assume that the exchange rate forecasts for the fairly stable scenario are appropriate for years 3 through 6. Also assume that the other information already provided on net cash flows, financing costs, the 10 percent withholding tax, the salvage value, and the parents required rate of return is still appropriate. What would be the minimum dollar price (after taxes) that North Star should receive to divest the subsidiary? Substantiate your opinion.

CHAPTER 14 NoRTH STAR COMPANY Capital Budgeting This case is imnded to Bustrate that the vlue of an tenational project i siive varicus types of input s is intmded to show how a compuer speadsheet forma This case can be performed uning an electromic spreadsheet nach n Excel The bollo ing present value factors ay be belpleal impt lo dincoating cah For consistemcy in dscusion of this case, you should develop yoer copater pead sheot in a format hat reenbles the one used in Chiper 14, with each year represeing tine needed so complete this ca Noth Star Company is considering establahing a subeidiary to manfacture cothing Sinppene. Is sales would be insokell in Singapone llas 158 h fenast net ah flows to the abeidhary as fo These cash ows do ot include fnancing cests (isterest espensses) on any n rowed in Singapore. Sorth Star Company also expects to receve 5530 milion after tase as a seult o slling the subsidiary at the end of year&Assame that there will not be withholding lans imposed on this amutL below Fity pencent of the net cash flows to the sbidary would be ranitted to the parent would be o the Usilted Stals The initia wment inclading iesmerat is working capital) by Noth Star in he bnidiay would be $8-40 milion Any investment in working captal liachKEunt, The initial invetment could be financed completely by the parent 520 mico weed at the present eschange rate of $ 50 per Singapore dellar to achieve $540 mion Exhibit B.3