From the Desk of Dr.
Imran Omer
Quiz 1
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 5 years, when he
expects to sell the subsidiary.
Ben 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.
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 5 years.
The estimated price and demand schedules during each of the next 4 years are shown
here:
Description Year 1 Year 2 Year 3 Year 4 Year 5
Price of Speedos 5,000 Thai 5,000 Thai 6,000 Thai 7,000 Thai 7,000 Thai
Bhat Bhat Bhat Bhat Bhat
Demand 125,000 pairs 125,000 225,000 225,000 225,000
pairs pairs pairs pairs
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 5 years.
From the Desk of Dr. Imran Omer
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 5 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.
Required:
Solve all situations separately:
i) Conduct a capital budgeting analysis from parent’s perspective to determine whether
parent company should establish a subsidiary.
ii) Assume that all the funds are blocked by host country until the subsidiary is sold and
the subsidiary must reinvest those funds until that time. The subsidiary uses the
blocked funds to purchase marketable securities that are expected to yield 7 percent
annually after taxes.
iii) From the parent’s perspective, would the NPV of this project be more sensitive to
exchange rate movements if the subsidiary uses financing to cover the working
capital or if the parent invests more of its own funds to cover the working capital?
Explain.
