Question
Suppose that Sherman Co., a U.S.-based MNC is considering a plan to establish a subsidiary in Singapore. The MNC would establish the subsidiary using an
Suppose that Sherman Co., a U.S.-based MNC is considering a plan to establish a subsidiary in Singapore. The MNC would establish the subsidiary using an upfront investment of $10,000,000 and would sell the subsidiary after four years. While it is confident in the values of certain parameters of the capital budgeting analysis, there is some substantial risk in the tax rate on earnings remitted from Singapore as well as the salvage value.
In particular, Sherman believes that there are two possible tax rates with the following probabilities.
Possible Tax Rate Outcome | Probability of Outcome |
---|---|
10.00% | 70.00% |
20.00% | 30.00% |
100% |
Additionally, Sherman believes that there are two possible salvage values with the following probabilities.
Possible Salvage Value Outcome | Probability of Outcome |
---|---|
$12,000,000 | 60.00% |
$7,000,000 | 40.00% |
100% |
Since there are two possible values for the tax rate, and two possible values for the salvage value, there are four total scenarios as outlined in the following table.
Scenario | Withholding Tax | Salvage Value |
---|---|---|
1 | 10.00% | S$12,000,000 |
2 | 20.00% | S$12,000,000 |
3 | 10.00% | S$7,000,000 |
4 | 20.00% | S$7,000,000 |
Given these scenarios, Sherman seeks to estimate the expected net present value of the project in the face of this uncertainty.
Now that you have calculated the NPV for scenario 2, Sherman management has provided you with the net present value of the project under the other scenarios as well, as shown in the table.
Given the probabilities of each tax rate scenario, and each salvage value scenario, complete the last column of the table, filling in the (joint) probability of each scenario occurring.
Hint: Assume that the value of the tax rate and the salvage value are independent of each other.
Scenario | Tax Rate | Salvage Value | NPV | Probability |
---|---|---|---|---|
1 | 10.00% | $12,000,000 | $3,234,161 |
|
2 | 20.00% | $12,000,000 | $2,144,868 |
|
3 | 10.00% | $7,000,000 | $1,804,778 |
|
4 | 20.00% | $7,000,000 | $715,485 |
|
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