XYZ Inc. is a USA electric heater manufacturer. They are considering establishing operations in France. The new wholly foreign owned subsidiary is going to supply finished products to the French market. The cost to purchase and equip the manufacturing facilities is €21,600,000. Perform an NPV analysis to determine whether this is a good investment, under the following assumptions:

1. The pound/euro exchange rate is currently £0.82/€ and the dollar is expected to appreciate/depreciate at a rate justified by the expected basic interest rate differential between the USA and France. The USA basic interest rate is 0.75% and the French basic interest rate set by the ECB is 0%
2. XYZ sells an electric heater for €72 in the first year. This unit price will increase by 2.5% for the 2 years after that.
3. Demand for electric heaters in France will be 200,000 units in the first year, then grows at the rate of 20% per annum for the next 2 years due to the adverse weather forecasts.
4. The variable unit cost of production will be €50 per unit.
5. Total administrative costs will be €1,200,0000.
6. Depreciation of fixed assets worth €21,600,000 invested in year 0 will be taken on a straight-line basis over 20 years.
7. Profits earned by the French subsidiary are subject to 26.5% corporate income tax rate in France. Dividends paid to the USA parent are exempt from withholding tax.
8. Annual net working capital will average 6% of total revenue of the same year.
9. The pound-denominated equity discount rate for the project is 16.7%
10. After year 3, the pound free cashflows to USA parent will grow at the expected rate of 4% indefinitely.
11. All the French subsidiary’s free cashflows will be paid to the USA parent as dividends. The USA government imposes a 19% tax rate on the foreign earnings repatriated to the USA as dividends.

Answer rating: 100% (QA)

Solution 1 Assuming a discount rate of 75 PV of cash flows Year 0 21600000 Year 1 16200000 Year 2 18000000 Year 3 19800000 Year 4 21600000 NPV 21600000 162000001075 1800000010752 1980000010753 2160000... View the full answer