Spartan Inc. is considering the development of a subsidiary in Singapore that could manufacture and sell tennis rackets locally. Various departments of Spartan Inc. were asked to supply relevant information for a capital budgeting analysis. In addition, some executives of Spartan Inc. met with government officials of Singapore regarding the proposed subsidiary. All relevant information follows:
1. Initial investment. An estimated 20 million Singapore dollars (S$), which includes funds to support working capital, would be needed for the project. Given the existing spot rate of $0.50 per Singapore dollar, the U.S.- dollar amount of the parentâ??s initial investment is $10 million.
2. Project life. The project is expected to end in four years. The host government of Singapore has promised to make a payment to the parent in order to purchase the plant after four years.
3. Price and demand. The estimated price and demand schedules during each of the next four years are shown here:
Year Price per Racket Demand in Singapore
1 S$330 60,000 units
2 S$350 70,000 units
3 S$360 90,000 units
4 S$380 100,000 units
4. Costs. The variable costs ( for materials, labor, etc.) per unit were estimated and consolidated as shown here:
Year Variable Costs (VC) per Racket
The expense of teasing extra office space is S$1 million per year. Other annual overhead expenses are expected to be S$1 million per year.
5. Exchange Rates. The spot exchange rate of Singapore dollar is $0.50. The spot rate is used by Spartan Inc. as its best forecast of the exchange rate that will exist in the future periods. Thus, the forecasted exchange rate for all future periods is $0.50.
6. Host country taxes on income earned by subsidiary. The Singapore government will allow Spartan Inc. to establish the subsidiary and will impose a 20 percent tax rate on income. In addition, it will impose a 10 percent withholding tax on any funds remitted by the subsidiary to the parent.
7. U.S. government taxes on income earned by Spartan subsidiary. The U.S. government will allow a tax credit on taxes paid in Singapore, so that earnings remitted by the parent will not be taxed by the U.S. government.
8. Cash flows from Spartan subsidiary to parent. The Spartan subsidiary plans to send all net cash flows received back to the parent firm at the end of each year. The Singapore government promises no restrictions on the cash flows to be sent back to the parent firm, but does impose a 10 percent withholding tax on any funds sent to the parent, as mentioned earlier.
9. Depreciation. The Singapore government will allow the subsidiary of Spartan Inc. to depreciate the cost of the plant and equipment at a maximum rate of S$2 million per year, which is the rate to be used by the subsidiary.
10. Salvage value. The Singapore government will send a payment of S$12 million to the parent to assume ownership of the subsidiary at the end of four years.
11. Required rate of return. Spartan Inc. requires a 15 percent return on this project.
The NPV of an initial investment is determined.