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International Capital Budgeting Mini-Case

Esmeralda, Inc., is considering the development of a subsidiary in Singapore that would manufacture and sell baseball bats locally. Esmeralda’s financial
managers have asked the manufacturing, marketing, and financial departments to provide them with relevant input so they can apply a capital budgeting
analysis to this project. In addition, some Esmeralda executives have met with government officials in Singapore to discuss the proposed subsidiary. The
project would end in four years. All relevant information follows.
a. Initial investment. The project would require an initial investment of 20 million Singapore dollars (S$), which includes funds to support working capital.
b. Price and consumer demand. The estimated price and demand schedules during each of the next four years are shown in the Excel template.
c. Cost. The variable costs (for materials, labor, etc.) per unit have been estimated and consolidated as shown in the Excel template.
d. Tax laws. The Singapore government will allow Esmeralda’s subsidiary to depreciate the cost of the plant and equipment at a maximum rate of S$2 million
per year, which is the rate the subsidiary will use. The Singapore government will impose a 20 percent tax rate on income. In addition, it will impose a 10
percent withholding tax on any funds remitted by subsidiary to the parent. The U.S. government will allow a tax credit on taxes paid in Singapore; therefore,
earnings remitted to the U.S. parent will not be taxed by the U.S. government.
e. Remitted funds. The Esmeralda subsidiary plans to send all net cash flows received back to the parent firm at the end of each year. The Singapore
government promises no restrictions on the cash flows to be sent back to the parent firm but does impose a 10 percent withholding tax on any funds sent to
the parent, as mentioned previously.
f. Exchange rates. The spot exchange rate of the Singapore dollar is $.74. Esmeralda currently uses the spot rate as its forecast for all future periods.
g. Salvage value. The Singapore government will pay the parent S$12 million to assume ownership of the subsidiary at the end of four years. Assume that
there is no capital gains tax on the sale of the subsidiary.
h. Required rate of return. Esmeralda, Inc., requires a 15 percent return on this project.
1. Base Case: Compute the NPV of the project based on projected cash flows to and from the parent.
2. Consideration of Exchange Rate Fluctuations: Esmeralda knows that the exchange rate will typically change over time, but it does not know whether the
Singapore dollar will strengthen or weaken in the future.
A. Which would be preferred from the perspective of the parent company, appreciation or
depreciation of the Singapore dollar? Explain carefully?
B. Download the series of monthly exchange rates between the USD and Singapore dollar for the
last five years by following the steps below:
i. Go to and search USD/SGD
ii. Click Historical Data tab
iii. Choose Time period: 5Y and Frequency: Monthly, then click Apply tab. iv. Download the data to Excel and keep the Date and Adj Close Columns.
C. Perform a trend analysis on the downloaded historical data to make the following projections from the perspective of the U.S. parent:
i. What is your optimistic forecast of the exchange rate over each of the next five years? Provide the numbers and explain how you arrive at this forecast.
ii. What is pessimistic forecast of the exchange rate over each of the next five years? Provide the numbers and explain how you arrive at this forecast.
D. Based on your exchange rate forecasts, what are your optimistic and pessimistic estimates for NPV from the parent’s perspective?3.Hedged Exchange
Rates: Suppose Esmeralda plans to hedge some of its expected cash flows if it implements the project. It would hedge cash flows of S$4,000,000 per year,
and leave any additional cash flows unhedged. Assume that the prevailing forward rate is 96% of the current spot rate for any maturity.
• What is the NPV under this assumption?
• Under what circumstances would you advise the firm against hedging?
4. Remittance of funds to parent: Esmeralda, Inc. is considering an alternative strategy for remittance
of funds back to the parent.
• What would be the advantages and disadvantages of remitting less than 100% of the funds back
to the parent during the project’s 4-year life?
• Suppose the subsidiary remitted only 75% of funds to the parent during the project’s 4-year life?
What impact will this have on NPV? Make reasonable assumptions about any additional information you need to complete the NPV analysis.