Homework 3 - International Financial Management | FINA 4360, Assignments of International Finance and Trade

Download Homework 3 - International Financial Management | FINA 4360 and more Assignments International Finance and Trade in PDF only on Docsity! International Finance Rauli Susmel FINA 4360 Homework 3 3.1 (Ch. 13) DFI to Reduce Cash Flow Volatility. Raider Chemical Co. and Ram, Inc., had similar intentions to reduce the volatility of their cash flows. Raider implemented a long-range plan to establish 40 percent of its business in Canada. Ram, Inc., implemented a long-range plan to establish 30 percent of its business in Europe and Asia, scattered among 12 different countries. Which company will more effectively reduce cash flow volatility once the plans are achieved? 3.2 (Ch. 13) Capitalizing on Low-Cost Labor. Some MNCs establish a manufacturing facility where there is a relatively low cost of labor. Yet, they sometimes close the facility later because the cost advantage dissipates. Why do you think the relative cost advantage of these countries is reduced over time? (Ignore possible exchange rate effects.) 3.3 (Ch. 14) Capital Budgeting Analysis. Wolverine Corp. currently has no existing business in New Zealand but is considering establishing a subsidiary there. The following information has been gathered to assess this project: · The initial investment required is USD 50 million in NZDs (NZD ). Given the existing spot rate of USD .50 per NZD, the initial investment in USDs is USD 25 million. In addition to the NZD 50 million initial investment for plant and equipment, NZD 20 million is needed for working capital and will be borrowed by the subsidiary from a New Zealand bank. The New Zealand subsidiary will pay interest only on the loan each year, at an interest rate of 14 percent. The loan principal is to be paid in 10 years. · The project will be terminated at the end of Year 3, when the subsidiary will be sold. · The price, demand, and variable cost of the product in New Zealand are as follows: Year Price Demand Variable Cost 1 NZD 500 40,000 units NZD 30 2 NZD 511 50,000 units NZD 35 3 NZD 530 60,000 units NZD 40 · The fixed costs, such as overhead expenses, are estimated to be NZD 6 million per year. · The exchange rate of the NZD is expected to be USD .52 at the end of Year 1, USD .54 at the end of Year 2, and USD .56 at the end of Year 3. · The New Zealand government will impose an income tax of 30 percent on income. In addition, it will impose a withholding tax of 10 percent on earnings remitted by the subsidiary. The U.S. government will allow a tax credit on the remitted earnings and will not impose any additional taxes. · All cash flows received by the subsidiary are to be sent to the parent at the end of each year. The subsidiary will use its working capital to support ongoing operations. · The plant and equipment are depreciated over 10 years using the straight-line depreciation method. Since the plant and equipment are initially valued at NZD 50 million, the annual depreciation expense is NZD 5 million. · In three years, the subsidiary is to be sold. Wolverine plans to let the acquiring firm assume the existing New Zealand loan. The working capital will not be liquidated but will be used by the acquiring firm when it sells the subsidiary. Wolverine expects to receive NZD 52 million after subtracting capital gains taxes. Assume that this amount is not subject to a withholding tax. · Wolverine requires a 20 percent rate of return on this project. a. Determine the net present value of this project. Should Wolverine accept this project? b. Assume that Wolverine is also considering an alternative financing arrangement, in which the parent would invest an additional USD 10 million to cover the working capital requirements so that the subsidiary would avoid the New Zealand loan. If this arrangement is used, the selling price of the subsidiary (after subtracting any capital gains taxes) is expected to be NZD 18 million higher. Is this alternative financing arrangement more feasible for the parent than the original proposal? Explain. c. From the parent’s perspective, would the NPV of this project be more sensitive to exchange rate movements if the subsidiary uses New Zealand financing to cover the working capital or if the parent invests more of its own funds to cover the working capital? Explain. d. Assume Wolverine used the original financing proposal and that funds are blocked until the subsidiary is sold. The funds to be remitted are reinvested at a rate of 6 percent (after taxes) until the end of Year 3. How is the project’s NPV affected? e. What is the break-even salvage value of this project if Wolverine uses the original financing proposal and funds are not blocked? 3.4 (Ch. 15) Valuing a Foreign Target. Blore Inc., a U.S.-based MNC, has screened several targets. Based on economic and political considerations, only one eligible target remains in Malaysia. Blore would like you to value this target and has provided you with the following information: · Blore expects to keep the target for three years, at which time it expects to sell the firm for 300 million Malaysian ringgit (MYR) after any taxes. · Blore expects a strong Malaysian economy. The estimates for revenue for the next year are MYR 200 million. Revenues are expected to increase by 8% in each of the following two years. · Cost of goods sold are expected to be 50% of revenue. · Selling and administrative expenses are expected to be MYR30 million in each of the next three years. · The Malaysian tax rate on the target's earnings is expected to be 35 percent. · Depreciation expenses are expected to be MYR 20 million per year for each of the next three years. · The target will need MYR 7 million in cash each year to support existing operations. · The target's stock price is currently MYR 30 per share. The target has 9 million shares outstanding. · Any remaining cash flows will be remitted by the target to Blore Inc. Blore uses the prevailing exchange rate of the MYR as the expected exchange rate for the next three years. This exchange rate is currently .25 USD/MYR · Blore's required rate of return on similar projects is 20 percent. a. Prepare a worksheet to estimate the value of the Malaysian target based on the information provided.