Sportive Inc., a U.S based MNC is considering the development of a subsidiary in Singapore that would manufacture and sell tennis rackets locally in Singapore. Sportives management has asked various departments to supply relevant information for a capital budgeting analysis. In addition, some Sportive executives have met with government officials in Singapore to discuss the proposed subsidiary. The following information is relevant:

• Initial investment: An estimated 10 million Singapore dollars (S$), which includes funds to support working capital, would be needed for the project.

• Project life: The project is expected to end in four years. The host government of Singapore has promised to purchase the plant from the parent after four years.

• Price, demand and variable costs: The estimated price, demand and variable costs are as follows:

Year	Variable Costs Per Racket	Price Per Racket	Demand In Singapore
1	S$ 100	S$ 175	30,000 units
2	S$ 100	S$ 175	30,000 units
3	S$ 125	S$ 180	50,000 units
4	S$ 130	S$ 190	50,000 units

• Other Costs: The expense of leasing extra office space is S$ 500,000 per year. Other annual overhead expenses are expected to be S$ 500,000 per year.

• Exchange rates: The spot exchange rate of the Singapore dollar is $.50. Sportive uses the spot rate as its best forecast of the exchange rate that will exist in future periods.

• Host government taxes on income earned by subsidiary: The Singapore government will allow Sportive Inc. to establish the subsidiary and will impose a 20% tax rate on income. In addition, it will impose a 10% withholding tax on any funds remitted by the subsidiary to the parent.

• U.S government taxes on income earned by Sportive subsidiary: The U.S government will allow a tax credit on taxes paid in Singapore; therefore, earnings remitted to the U.S parent will not be taxed by the U.S government.

• Cash flows from Sportive Subsidiary to parent: The Sportive subsidiary plans to send all net cash flows received back to the parent firm at the end of each year. The Singapore government promises no restrictions on the cash flows to be sent back to the parent firm but imposes a 10% withholding tax on any funds remitted as mentioned above.

• Depreciation: The Singapore government will allow Sportives subsidiary to depreciate the cost of the plant and equipment at a maximum rate of S$ 1 million per year, which is the rate the subsidiary would use.

• Salvage value: The Singapore government will pay the parent S$ 6 million to assume ownership of the subsidiary at the end of the four years. Assume there is no capital gains tax on the sale of the subsidiary.

• Required rate of return: Sportive Inc. requires a 15% return on this project.

REQUIRED:

1. Should the capital budgeting analysis be assessed from the subsidiarys perspective or from the parents perspective? [2 marks]

2. What additional factors that normally are not relevant for a purely domestic project deserve consideration in multinational capital budgeting? [2 marks]

3. Given that the investment in Singapore was entirely in U.S dollars, describe Sportives exposure to exchange rate risk resulting from the project. [2 marks]

4. Explain how the size of the parents initial investment and the exchange rate risk would have been affected if Sportive had financed much of the investment with loans from banks in Singapore. [2 marks]

5. Describe the factors that Sportive likely considered when estimating the future cash flows of the project in Singapore. [3 marks]

6. What factors did Sportive likely consider in deriving its required rate of return on the project in Singapore? [2 marks]

7. Describe the uncertainty that surrounds the estimate of future cash flows from the perspective of the U.S. parent. [3 marks]

8. Determine the Net Present Value (NPV) of this project. Should Sportive accept this project? [17 marks]

9. Sportive realizes that the exchange rate will typically change over time, but it does not know whether the Singapore dollar will strengthen or weaken in the future. Use the following exchange rates over the four-year period for the NPV analysis in the case where the Singapore dollar strengthens ($.54, $.57, $.61, $.65) and if it weakens (S$ $.47, $.45, $.40, $.37). How does this possibility affect the feasibility of the project? [5 marks]

10. Assume that the subsidiary borrows S$ 5 million to purchase the offices that are leased in the initial example. Also, assume that the subsidiary will make interest payments on this loan (of S$ 500,000) annually and will pay the principal (S$ 5 million) at the end of Year 4, when the project is terminated. Since the Singapore government permits a maximum of S$ 1 million per year in depreciation for this project, the subsidiarys depreciation rate will remain unchanged. Assume the offices are expected to be sold for S$ 5 million after taxes at the end of Year 4. How does this change the NPV of the Project? [5 marks]

11. Assume that instead of the subsidiary leasing the offices or purchasing them with borrowed funds, the parent uses its own funds to purchase the offices for S$ 5 million. What revisions must be made to the capital budgeting analysis, and how does it affect the NPV? [3 marks]

12. Assume the host country requires that earnings generated by the subsidiary be reinvested locally for at least 3 years before they can be remitted. If the yield on the money market is 5% per annum after taxes, how would this affect the accept/reject decision on the project? [4 marks]