Kubota—the Japanese manufacturer of tractors and small earthmoving equipment—is considering building an assembly plant in Da Nang (Vietnam). The initial investment would amount to dong (VND)

200 billion (US$10 million) and would be financed partly (50 percent) by a loan from the Vietcong Bank in VND at the subsidized rate of 6 percent over five years with bullet principal repayment at the end of year 5 and partly (30 percent)

by a revolver from Mitsubishi-Tokyo Bank at TIBOR + 120 basis points.

The balance of the initial investment is in the form of equity provided by Kubota-

Japan.

Output is planned at 5,000 small bulldozers per year. Sale price is VND 200 million/unit. Power train and chassis would be imported from Japan for VND 100 million cif/unit. Locally sourced parts and labor cost amount to VND 75 million/unit.

Kubota-Vietnam is granted a corporate income tax holiday and will pay a 5 percent royalty to its Japanese parent. Kubota estimates that the project will displace 750 units that are currently exported directly from Japan to Vietnam.

Export sales have a profit margin of 15 percent.

Assume that VND 20,000 = ¥100 over the life of the project and that the TIBOR floating rate revolver can be swapped in a five-year fixed-rate loan paying 3. 5 percent.

a. Map out the project’s cash flows and identify the different risks that may derail it.

b. What is the operating exposure of the project to a devaluation of VND?

c. Would you recommend that Kubota invest in Japan? Kubota applies a cost of equity capital set at 14 percent for this kind of project.