SCENARIO 3. ABC Ltd is a US-based company manufacturing and selling Electronics in the US market. ABC Ltd exports Electr

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SCENARIO
3. ABC Ltd is a US-based company manufacturing and selling
Electronics in the US market. ABC Ltd exports Electronics to New
Zealand and the United Kingdom. Currently, ABC Ltd has no existing
business in New Zealand but is considering establishing a
subsidiary there.
Following information related foreign has been given to you.
The initial investment required is 40 million in New Zealand
dollars (NZ$). Given the existing spot rate of $0.5 per New Zealand
dollar, the initial investment in U.S. dollars is $ 20 million. In
addition to the NZ$ 40 million initial investment for plant and
equipment, NZ$10 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 12 per cent. The loan principal is to be paid in 3
years. In three years, the subsidiary is to be sold. ABC Ltd plans
to settle the New Zealand loan by using the salvage value. The
working capital will not be liquidated but will be used by the
acquiring firm when it sells the subsidiary. ABC Ltd expects to
receive NZ $31 million after subtracting capital gains taxes
(Acquiring firm will not take the bank loan). Assume that this
amount is not subject to a withholding tax.
Forecast of demand for electronics and other expenses.
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 NZ$500 60,000 units NZ$150
2 NZ$550 72,000 units NZ$165
3 NZ$605 86,400 units NZ$182
✓ The fixed costs, such as overhead expenses, are estimated to be
NZ$1,300,000 per year and assume it will not change due to
inflation.
✓ The exchange rate of the New Zealand dollar is expected to be
$0.45 at the end of Year 1, $0.42 at the end of Year 2, and $0.40
at the end of Year 3.
Tax policies of New Zealand government
The New Zealand government will impose an income tax of 20% per
cent on income. In addition, it will impose a withholding tax of 8%
per cent 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.
5
Other information
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 3 years using the
straight-line depreciation method. Cost of the plant and machines
was NZ$40,000,000 and salvage value is NZ$31,000,000.
ABC Ltd requires an 11 % per cent rate of return on this
project.
Required
a. Calculate the NPV of the project and advice the management on
taking up this project or reject the project. You should justify
your suggestion using appropriate calculations.
( 30 marks)
b. Evaluate Political Risk Characteristics and Financial Risk
Characteristics ABC Ltd face in stating the business in New Zealand
and application of Risk-adjusted discount rate.
(10 marks)
(Total 40 marks for section C)
(End
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