Immediate with Detail Calculations step by step plz...

QUESTION 5 (20 MARKS)

A U.S. furniture manufacturer FD is considering establishing a subsidiary in New Zealand. The initial investment in plant and equipment required is NZ$50 million in New Zealand dollars, depreciated over 10 years using the straight-line depreciation method. Given the existing spot rate of USD 0.50 per New Zealand dollar, the initial investment in U.S. dollars is $25 million. In addition, NZ$20 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 14 percent. The loan principal is to be paid in 10 years. 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 40,000 units NZ$30

2 NZ$511 50,000 units NZ$35

3 NZ$530 60,000 units NZ$40

The fixed costs such as overhead expenses, are estimated to be NZ$6 million per year.

The New Zealand government will impose a corporate tax of 30%. In addition, it will impose a withholding tax of 10% on earnings remitted by the subsidiary. The U.S. government will not impose any additional taxes on the remitted earnings. 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. In three years, the subsidiary planned to be sold. FD plans to let the acquiring firm assume the existing New Zealand loan. The working capital will not be liquidated but will be used by the acquiring firm when it sells the subsidiary. FD expects to receive NZ$52 million after subtracting capital gains taxes. Assume that this amount is NOT subject to a withholding tax. FD Corporation requires a 20% rate of US dollar return on this project. The exchange rates of the New Zealand dollar are expected to be $.52, $.54 and $.56 at the end of Year 1, 2, and 3 respectively.

Required:

a. Should FD accept this project? (8 Marks)

b. Assume that funds are blocked until the subsidiary is sold. The funds to be remitted are reinvested at a rate of 6 percent (after taxes) until the end of Year 3. Is the projects NPV affected? Justify your answer. (12 Marks)