WK plc is a UK company which plans to set up a manufacturing subsidiary in the small country of Parland, whose currency is the dollar. An initial investment of $5m in plant and machinery is needed. Initial investment in working capital of $500,000 would be financed by a loan from a local bank, at an annual interest rate of 10 per cent per year. At the end of five years, the subsidiary would be sold as a going concern for $12m and part of the proceeds would be used to pay off the bank loan. 

The subsidiary is expected to produce net cash flows from operations of $3m per year in current price terms over the five-year period, before allowing for Parland inflation of 8 per cent per year. Capital allowances on the initial investment in plant and machinery are available on a straight-line basis at 20 per cent per year. As a result of setting up the subsidiary, WK plc expects to lose after-tax export income from Parland of £80,000 per year in current price terms, before allowing for UK inflation of 3 per cent per year. 

Profits in Parland are taxed at a rate of 20 per cent after interest and capital allowances. All after-tax cash profits are remitted to the UK at the end of each year. UK tax of 24 per cent is charged on UK profits, but a tax treaty between Parland and the UK allows tax paid in Parland to be set off against any UK liability. Taxation is paid in the year in which the liability arises. WK plc requires foreign investments to be discounted at 15 per cent. The current exchange rate is $2.50/£1 and the dollar is expected to depreciate against sterling by 5 per cent per year. Should WK plc undertake the investment in Parland?