ABC Ltd, a Kenyan firm own a subsidiary in Blueland. The subsidiary has an investment opportunity, which will cost 40 million Blues (Blues (B) is the currency of Blueland). ABC plans to invest directly B20 million while the subsidiary will use B10 million of its retained earnings and B10 million of locally borrowed funds at 10% interest. The project will generate revenue of B7.5 million in real terms annually for the next five years. The subsidiary will import components from ABC Ltd worth B2 million per year, but ABC ltd will suffer diseconomies of scale to the extent of B1 million annually due to shifting production to the host country.

The salvage value at the end of five years is estimated to be B1.5 million. The inflation rate in Blueland is estimated at 5% per year while the inflation rate in Kenya is estimated at 10%. ABC ltd uses CAPM to estimate the appropriate discount rate. The risk free rate is expected to be 10%, the expected market return, 15% and the beta, 0.8. The spot exchange rate is B 1.5 per KSh.1 while the corporate tax rate in Blueland is 30%. Assume that the subsidiary uses straight-line depreciation method, profit repatriation is blocked for first two years and PPP holds.

Required

Using the NPV method, advice ABC Ltd on whether to undertake the project

Answer rating: 100% (QA)

Solution Investment amount B 40 Million Funded by ABC Itd B 20 Million Funded by subsidiary B 20 ... View the full answer