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Spartan, Inc. Net present value analysis

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4. Spartan Inc. (a US based MNC) is planning to open a subsidiary in Switzerland to manufacture 
shoes. The new plant will cost SF 1.1 billion. The salvage value of the plant at the end of the 4 yr 
economic life is estimated to be SF 200 million net of any tax effects. This plant will also call for 
extra inventory holding of SF 300 million, and extra accounts payables of SF 200 million.  Projected 
sales from this new plant are SF 800 million per year. The fixed costs are estimated to be SF 300 
million per year, and the variable costs are estimated to be SF 100 million per year.  Depreciation 
on the new plant after accounting for the salvage value will be SF 300 million per year. The Swiss 
government will impose a 35 % tax on the earnings. US govt. will not impose any taxes. 100 % of 
the cash flows will be remitted to the parent. The exchange rate is expected to be stable at $ 0.80 
per SF.  Spartan requires 15 % return on its capital investments.  

Please compute:   
  a) Net Investment Cost of the plant  
  b) Cash flows in years 1 through 4 of the project 
  c) Net Present Value of the project 
  d) Internal Rate of Return (IRR) of the project   
  e) Should the project be accepted or rejected? Why or why not?
f) If the exchange rate scenario unfolds as follows, 
   t = time          0=$0.80/SF 1= $0.70/SF  2=$0.70/SF  3=$0.60/SF   4=$0.55/SF     
  Re‐compute the NPV. Is the project still acceptable? Why or why not? 
  g) If the exchange rate scenario were to unfold as follows, 

    t=time           0= $0.80/SF  1=$0.80/SF 2= $0.95/SF  3=$0.95/SF    4= $1.00/SF 
  Re‐compute the NPV. Is the project still acceptable? Why or why not?

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Solution Summary

How exchange rates affect net present values

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NPV of an Initial Investment

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
1. S$200
2. S$220
3. S$240
4. S$260

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.

Given the information above, calculate the Net Present Value from the point of view of the parent company. Do you recommend the implementation of this project to the Spartan Inc.?

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