Havel Robotics Company (a U.S.-based firm) exports 25,000 industrial robots per year to China under an agreement that covers a 5-year period. In China, the robots are sold for the RMB (Chinese currency) equivalent of $50 per unit. The total costs in the United States are direct manufacturing costs and shipping costs, which amount to $35 per unit. The market for industrial robots in China is stable, and Havel holds the major portion of the market. 

In 2020, the Chinese government, adopting a policy of replacing imported robots with local products, invited Havel to open an assembly plant in China. If Havel makes the investment, it will operate the plant for five years and then sell the building and equipment to Chinese investors at net book value (cost less accumulated depreciation) at the time of sale plus the current amount of any working capital. Havel will be allowed to repatriate 100 percent of cash flow from operations (net income plus depreciation) to the United States each year. 

Havel’s anticipated outlay in 2020 would be $1,500,000 (buildings and equipment, $750,000, and working capital, $750,000). Buildings and equipment will be depreciated over five years on a straight-line basis (no salvage value). At the end of the fifth year, the $750,000 of working capital may be repatriated to the United States. 

Locally assembled robots will be sold for the RMB equivalent of $50 each. Operating expenses per robot are as follows: 

Materials purchased china...................................$15

(dollar equivalent of RMB cost)

Components imported from U.S parent ...............8

Variable costs per unit ..........................................$23

The $8 transfer price per unit for components sold by Havel to its Chinese subsidiary consists of $4 of direct costs incurred in the United States and $4 of pretax profit to Havel. There are no other operating costs in either China or the United States. 

The corporate income tax rates in China and the United States are 25 percent and 21 percent, respectively. Havel uses a 15 percent discount rate to evaluate all its investment projects. The present value factor for a single payment in five periods at 15 percent is 0.497. The present value factor for an annuity of payments for five periods at 15 percent is 3.352. Assume the investment is made at the end of 2020, and all operating cash flows occur at the end of 2021 through 2025. The RMB/U.S. dollar exchange rate is expected to remain constant over the 5-year period. 

Required: 

a. Assuming that Havel uses a parent company perspective in making foreign capital investment decisions, do you recommend that the company make the investment? 

b. Havel learns that if it decides not to invest in China, a German company will probably make an investment similar to that being considered by Havel. The German investment would be protected by the Chinese government against imports by other foreign robot manufacturers. How does this information affect your analysis and recommendation?