The Velo Rapid Revolutions Inc., a company that produces bicycles, elliptical trainers, scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase firms revenues by euro 600,000 in year 1 and it will increase by 15% per year for the next 5 years, however; firms additional expenses will also 45% of the additional revenues. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC of 25% of additional revenues (to be recovered at the sale of the equipment at the end of five years). (Note: the terminal value of the project in year 5 may change total after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The current spot rate is $0.95/euro. Assume PPP hold for the next 5 years, and the expected inflation rate in the U.S. is 2% per year and 1% per year in Europe. The firm's required rate of return is 12% and no additional funds need be invested in the U.S. subsidiary during the period under consideration. The EU imposes no restrictions on repatriation of any funds of any sort. The EU corporate tax rate is 34% and the United States rate is 21%. Both countries allow a tax credit for taxes paid in other countries. Is the investment attractive to Velo Rapid Revolutions Inc.? Please focus on both subsidiary and parent point of view in the multinational capital budgeting process.
Assumptions		0	1	2	3	4	5
Original investment (EURO)		1,200,000
Installation		300,000
Spot exchange rate (USD per EUR)		0.95
Initial additional revenue			600,000.00
Revenue growth rate				15%	15%	15%	15%
US inflation			2%	2%	2%	2%	2%
EU inflation			1%	1%	1%	1%	1%
Depreciation	20%
Salvage value (Euro)							500,000
Capital gain on salvage value, so the net salvage value
Project Viewpoint (in US$)		0	1	2	3	4	5
Initial investment
Revenues
Less costs of manufacturing and fixed cost	40%
Less depreciation	20%
Earnings before taxes
Less EU corporate income taxes	34%
Net income
Add back depreciation
Less additional working capital investment	25%
Net changes in working capital
Salvage value
Free cash flow for discounting
Present value factor	12%
Present value of cash flows
Cumulative NPV
Parent Viewpoint (US$)		0	1	2	3	4	5
Dividends remitted to US parent
Add back EU taxes deemed paid
Grossed up dividend
Tentative US tax liability	21%
Less credit for EU taxes paid
Additional US taxes due on foreign income
Cash dividend less added US taxes plus depreciation
Initial investment & working capital
Plus sale value at end of 5 years
Parent cash flows (US$)
Present value factor	12%
Present value of cash flow
Cumulative NPV