RiverHawk in US. currently has no existing business in Brazil but is considering establishing a subsidiary there. The following information has been gathered to assess this project:

The initial investment required is $10.4 million in Brazilian Real (BRL). Only 10 million BRL will be on Plants and Equipment, which will be depreciable. The current spot for BRL is USD .25. In addition to the BRL 10.4 million initial investment for plant and equipment, BRL 4 million is needed for working capital and will be borrowed by the subsidiary from a Brazil Bank. The Brazil Subsidiary will pay interest only on the loan each year, at an interest rate of 14 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.

The price, demand, and variable cost of the product in New Zealand are as follows:

Year Price Demand Variable Cost

1 BRL 100 40,000 units BRL 6

2 BRL 110 50,000 units BRL 7

3 BRL 120 60,000 units BRL 8

The fixed costs, such as overhead expenses, are estimated to be BRL 2 million per year.

The exchange rate of the BRL is expected to be $.24 at the end of Year 1, $.25 at the end of Year 2, and $..26 at the end of Year 3.

The Brazilian Government will impose one time single tax of 33 percent on all the income (capital gain or profit, or net income). In addition, it will impose a withholding tax of 10 percent on all the monies remitted by the subsidiary to its parent (foreign country). There is no exception to this tax including SV and income). The U.S. government will allow a tax credit on the remitted earnings and 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 straightline depreciation method. The annual depreciation amount will be calculated by dividing the depreciable asset , which is only 10 million by 10. Or, it is I million BRL not USD.

In three years, the subsidiary is to be sold. Riverhawk plans to let the acquiring firm assume the existing Brazil Bank loan. (SWAP Agreement) The working capital will not be liquidated but will be used by the acquiring firm when it sells the subsidiary. RiverHawk expects to receive BRL 14M million after tax (including capital gains taxes). Withholding tax rule applies here.

Wolverine requires a 20 percent rate of return on this project.

Use the above information for the next five questions.

1. What is the Original NPV of this project? (Original NPV)
2. What is the break-Even Salvage Value of this project? i.e., the Price to sell after tax but before the withholding tax? (BE-SV)