Quetion- Given the following information, prepare capital budget for a Canadian company contemplating entering the U.S. market. The experiment is for five (5) years and the Sales / Treasury team provided the following information:

The initial investment is US$10 million all-in

Sales are US$10 million in year 1 growing by US$1 million in each of the next four years so that sales in year 5 are US$14 million

The U.S. gross margin for all years is 50%

Fixed costs excluding depreciation are US$2 million per year

Depreciation is US$1 million per year

Parent royalty fees are 5% of U.S.$ sales (convert to Canadian dollars for the parent side effect)

U.S. tax rates are 30% for all years

The Canadian parent tax rates 30% and there is a full refund of U.S. taxes paid (assume zero additional Canadian taxes for this question).

The parent profit on intercompany sales is 10% of U.S. sales so for example US$ 1 million in year 1 (convert to Canadian dollars for the parent side effect)

The current spot exchange rate is par US$0.90 = C$1.00 (Time 0) and inflation is expected to be 4% in the US and 2% in Canada for the foreseeable future (Time 1 through Time 5)

The U.S. operation has a 3 beta with a parent domestic market return of 10% and a risk free rate of 5%. The target debt to equity ratio is 1:1 and the cost of debt after tax is 5%. WACC is 12.5%.

Years

0 1 2 3 4 5

FX rates US$1=C$X 1.11 1.09 1.07 1.05 1.03 1.01

Present Value Factors 1.000 0.889 0.790 0.702 0.624 0.555

Would you recommend this investment in the U.S. by the Canadian company? Why? Round amounts to dollars.