Question

• Martin, Inc., is considering the development of a subsidiary in Sydney, Australia that would manufacture and sell high quality guitars on the local Australian Market.
• As one of Martin’s financial managers, you have asked the finance, marketing and manufacturing departments to provide you with all of the relevant input so you can perform a capital budgeting analysis to determine whether to undertake this project or not.
• In addition, a contingent of Martin executives have met with Australian government officials in Sydney to discuss the proposed subsidiary.
• The project would end in 5 years. All of the relevant information that you need to perform this capital budgeting analysis follows here.

• Initial investment: A$12,500,000 million (A$ = Australian dollars)
• Price and consumer demand:

Year 1 and 2: 20,000 units @ A$650/unit

Year 3: 30,000 units @ A$760/unit

Year 4: 40,000 units @ A$850/unit

Year 5: 40,000 units @ A$880/unit

• Costs

Variable costs: Years 1 & 2 A$370/unit, Year 3 A$445/unit, Years 4 and 5 A$600/unit

Fixed costs: A$2,000,000 per year ( A$1,000,000 lease and A$1,000,000 other fixed expense)

• Depreciation A$1,000,000 per year
• Tax laws: 30% income tax
• Remitted funds: 15% withholding tax on remitted funds
• Exchange rates: Spot exchange rate of $US 0.65 for Australian dollar
• Salvage values: A$6 million
• Required rate of return: 18%

Given all of the preceding information, please create an Excel spread sheet that shows the year by year amounts that you have taken into consideration in your capital budget analysis and decide whether or not you will undertake this project.

Show your work; indicate your decision (do we do the project or not); and briefly explain

Answer 1

		Present Value(PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=discount rate=Required Return=18%=0.18
		N=Year   of Cash Flow
		Accumulated depreciation at end of 5 years(A$)	5,000,000	(5*1 million)
		Book Value at end of 5 years	7,500,000	(12500000-5000000)
		Salvage Value (A$)	6,000,000
		Loss on Salvage	1,500,000
		Tax Saving on Loss=30%*1500000	450,000
		After Tax Salvage Cash Flow (A$)	6,450,000	(6000000+450000)
	N	Year	0	1	2	3	4	5
	A	Initial investment(A$)	(12,500,000)
	b	Demand in Units		20,000	20,000	30,000	40,000	40,000
	c	Sales Price per unit(A$)		650	650	760	850	880
	d=b*c	Annual Revenue(A$)		13,000,000	13,000,000	22,800,000	34,000,000	35,200,000
	e	Variable Cost per unit (A$)		370	370	445	600	600
	f=b*e	Total Variable Costs(A$)		7,400,000	7,400,000	13,350,000	24,000,000	24,000,000
	g=d-f	Contribution Margin(A$)		5,600,000	5,600,000	9,450,000	10,000,000	11,200,000
	h	Fixed Costs(A$)		2,000,000	2,000,000	2,000,000	2,000,000	2,000,000
	i	Depreciation expenses(A$)		1,000,000	1,000,000	1,000,000	1,000,000	1,000,000
	j=g-h-i	Before tax Operating Income(A$)		2,600,000	2,600,000	6,450,000	7,000,000	8,200,000
	k=j*(1-0.3)	After Tax Operating Income (A$)		1,820,000	1,820,000	4,515,000	4,900,000	5,740,000
	l	Add:Depreciation (Non Cash expense)		1,000,000	1,000,000	1,000,000	1,000,000	1,000,000
	X=k+l	Annual Operating Cash Flow(A$)		2,820,000	2,820,000	5,515,000	5,900,000	6,740,000
	Y	Terminal Salvage Cash Flow(A$)						6,450,000
	CF=A+X+Y	Net Cash Flow	(12,500,000)	2,820,000	2,820,000	5,515,000	5,900,000	13,190,000
	p	Exchange Rate (USD per AUD)	0.65	0.65	0.65	0.65	0.65	0.65
	q=CF*p	Cash Flow in USD before withholding tax	-8125000	1833000	1833000	3584750	3835000	8573500
	r	Withholding tax		0.15	0.15	0.15	0.15	0.15
	s=q*(1-r)	Cash Flow in USD after withholding tax	-8125000	1558050	1558050	3047038	3259750	7287475	SUM
	PV=s/(1.18^N)	Present Valure	(8,125,000)	1,320,381	1,118,967	1,854,521	1,681,343	3,185,422	1,035,635	USD
	NPV=Sum of PV	Net Present Value	$1,035,635	USD
		Yes, we should undertake this project
		NPV is positive