Since Ben Holt, Blades chief financial officer (CFO), believes the growth potential for the roller blade market in Thailand is very high, he, together with Blades board of directors, has decided to invest in Thailand. The investment would involve establishing a subsidiary in Bangkok consisting of a manufacturing plant to produce Speedos, Blades high-quality roller blades. Holt believes that economic conditions in Thailand will be relatively strong in 10 years, when he expects to sell the subsidiary. Blades will continue exporting to the United Kingdom under an existing agreement with Jogs, Ltd., a British retailer. Furthermore, it will continue its sales in the United States. Under an existing agreement with Entertainment Products, Inc., a Thai retailer, Blades is committed to selling 180,000 pairs of Speedos to the retailer at a fixed price of 4,594 Thai baht per pair. Once operations in Thailand commence, the agreement will last another year, at which time it may be renewed. Thus, during its first year of operations in Thailand, Blades will sell 180,000 pairs of roller blades to Entertainment Products under the existing agreement whether it has operations in the country or not. If it establishes the plant in Thailand, Blades will produce 108,000 of the 180,000 Entertainment Products Speedos at the plant during the last year of the agreement. Therefore, the new subsidiary would need to import 72,000 pairs of Speedos from the United States so that it can accommodate its agreement with Entertainment Products. It will save the equivalent of 300 baht per pair in variable costs on the 108,000 pairs not previously manufactured in Thailand. Entertainment Products has already declared its willingness to renew the agreement for another 3 years under identical terms. Because of recent delivery delays, however, it is willing to renew the agreement only if Blades has operations in Thailand. Moreover, if Blades has a subsidiary in Thailand, Entertainment Products will keep renewing the existing agreement as long as Blades operates in Thailand. If the agreement is renewed, Blades expects to sell a total of 300,000 pairs of Speedos annually during its first 2 years of operation in Thailand to various retailers, including 180,000 pairs to Entertainment Products. After this time, it expects to sell 400,000 pairs annually (including 180,000 to Entertainment Products). If the agreement is not renewed, Blades will be able to sell only 5,000 pairs to Entertainment Products annually, but not at a fixed price. Thus, if the agreement is not renewed, Blades expects to sell a total of 125,000 pairs of Speedos annually during its first 2 years of operation in Thailand and 225,000 pairs annually thereafter. Pairs not sold under the contractual agreement with Entertainment Products will be sold for 5,000 Thai baht per pair, since Entertainment Products had required a lower price to compensate it for the risk of being unable to sell the pairs it purchased from Blades. Holt wishes to analyze the financial feasibility of establishing a subsidiary in Thailand. As a Blades financial analyst, you have been given the task of analyzing the proposed project. Since future economic conditions in Thailand are highly uncertain, Holt has also asked you to conduct some sensitivity analyses. Fortunately, he has provided most of the information you need to conduct a capital budgeting analysis. This information is detailed here: The building and equipment needed will cost 550 million Thai baht. This amount includes additional funds to support working capital. The plant and equipment, valued at 300 million baht, will be depreciated using straight-line depreciation. Thus, 30 million baht will be depreciated annually for 10 years. The variable costs needed to manufacture Speedos are estimated to be 3,500 baht per pair next year. Blades fixed operating expenses, such as administrative salaries, will be 25 million baht next year. The current spot exchange rate of the Thai baht is $.023. Blades expects the baht to depreciate by an average of 2 percent per year for the next 10 years. The Thai government will impose a 25 percent tax rate on income and a 10 percent withholding tax on any funds remitted by the subsidiary to Blades. Any earnings remitted to the United States will not be taxed again. After 10 years, Blades expects to sell its Thai subsidiary. It expects to sell the subsidiary for about 650 million baht, after considering any capital gains taxes. The average annual inflation in Thailand is expected to be 12 percent. Unless prices are contractually fixed, revenue, variable costs, and fixed costs are subject to inflation and are expected to change by the same annual rate as the inflation rate. Blades could continue its current operations of exporting to and importing from Thailand, which have generated a return of about 20 percent. Blades requires a return of 25 percent on this project in order to justify its investment in Thailand. All excess funds generated by the Thai subsidiary will be remitted to Blades and will be used to support U.S. operations. Holt has asked you to answer the following questions: 1. Should the sales and the associated costs of 180,000 pairs of roller blades to be sold in Thailand under the existing agreement be included in the capital budgeting analysis to decide whether Blades should establish a subsidiary in Thailand? Should the sales resulting from a renewed agreement be included? Why or why not? 2. Using a spreadsheet, conduct a capital budgeting analysis for the proposed project, assuming that Blades renews the agreement with Entertainment Products. Should Blades establish a subsidiary in Thailand under these conditions? 3. Using a spreadsheet, conduct a capital budgeting analysis for the proposed project assuming that Blades does not renew the agreement with Entertainment Products. Should Blades establish a subsidiary in Thailand under these conditions? Should Blades renew the agreement with Entertainment Products? 4. Since future economic conditions in Thailand are uncertain, Holt would like to know how critical the salvage value is in the alternative you think is most feasible. 5. The future value of the baht is highly uncertain. Under a worst-case scenario, the baht may depreciate by as much as 5 percent annually. Revise your spreadsheet to illustrate how this would affect Blades decision to establish a subsidiary in Thailand. (Use the capital budgeting analysis you have identified as the most favorable from questions 2 and 3 to answer this question.)