Reference no: EM133424731

Question: Wikaoka currently does not have a business in New Zealand, but plans to set up a subsidiary in that country.The following information has been collectedto evaluate this project:

• The required investment is 50 millionsNew Zealand dollars(NZ$). Given the spot exchangerate existing $0.50 per New Zealand dollar,the initial investment in US dollarsis 25 millions. In addition to the initial investment of NZ$50 million for plant and equipment, additional NZ$20 millions for working capital, which the subsidiary will borrow from a bank in New Zealand. The subsidiary will pay intereston the loan each year,at an annual rate of 14%. He The principal of the loan will be paid within10 years.
• The project will end at the end of Year 3, when the subsidiary is sold.
• The price, demand,and variable cost of the product in New Zealandare as follows:

• Fixed costs, such as overhead, are estimated to be NZ$6 millions per year.
• The New Zealand dollar exchange rate is expected to be $0.52 at the end of Year 1, $0.54 at the end of Year 2 and $0.56 at the end of Year 3.
• The New Zealand government will charge an income tax of 30%. In addition, a withholding tax of 10% on the profits transferred by the subsidiary. The US government will allow a tax credit on transferred profits and will not apply additional taxes.
• All cash flows received by the subsidiary will be sent to the parent at the end of each year. The subsidiary will use its working capital to support continuing operations.
• Plant and equipment will be depreciated over 10 years using the straight-line depreciation method. As originally plant and equipment are valued at NZ$50 million, depreciation expense annual is NZ$5 millions.
• The subsidiary will be sold after three years. Wiraoka plans to let the company that acquires it take over existing loan in New Zealand. The working capital (TC) will not be liquidated, but will be will use to acquire the subsidiary. Wiraoka expects to receive NZ$52 millions after subtracting the capital gains taxes. Assume this amount is not subject to withholding fiscal.
• The firm asks for a 20% rate of return on this project.

1. Determine the NPV of this project.Wiraoka must acceptit?
2. Suppose the firm is also considering an alternative financingarrangement, in which that the parent company would invest an additional$10 million to cover the needs of TC, of so that the subsidiary avoids the loan in New Zealand. If this convention is used, it is expected than the sale price of the subsidiary (after subtracting any income tax capital) is NZ$18 millionshigher. Is this financing agreementmore feasible for the parent company than the original proposal?explain.
3. the perspective of the matrix, would the NPV of this project be more sensitive to the movements in the T/C if the subsidiary uses New Zealand financing to cover the TC or if the parent investsmore own funds to cover it. Explain.
4. Assume that Wiraoka used the original funding proposal and that the funds are frozen until the subsidiaryis sold. The transferred funds are reinvested at a rate 6% (aftertax) until the end of Year 3. How does it influencethe project?
5. What is the equilibrium salvage value of this project if Wiraoka uses theoriginal financing and the funds are not frozen?
6. Suppose that the company decides to implement the project, using the proposalof original financing. Suppose further that, after one year, a New York firm Zeeland offers Wiraoka a price of US$27 millions after imposed by the subsidiary and do not change Wiraoka's original forecasts for the Years 2 and 3. Compare the present value of the expected cash flows if the firm retains the subsidiary at the sale price. Should Wiraoka sell the subsidiary?. Explain.