Finance 4550 International Capital Budgeting Exercise Due Date: Wednesday 4/18

Spring 12 25 points

I. You may compare results with others and get any help available on the process of Capital Budgeting, but you should do your own calculations for the specifics of the problem here. In other words, it is okay to work with others on the assignment, but do not just copy. I can provide clarification of the information and a reasonable amount of assistance on the process, but I will not give verification of results. II. The assignment must be done using a spreadsheet (e.g. Excel) and submitted electronically. This may be done via e-mail (preferred), or on a diskette. You must also submit a hard copy. If I do not receive both an electronic copy and a hard copy, YOU WILL NOT GET CREDIT. International Capital Budgeting Exercise: Woodex corporation, a manufacturer of baseball bats in the U.S., is considering the production of cricket bats for export to India. Using the information provided below, determine whether or not this venture would be expected to produce positive Net Present Value (NPV): Investment in production: To manufacture cricket bats, Woodex would need USD 600,000 worth of new equipment. The equipment would be located in existing unused factory space, so no expenditure on real property is necessary. The production machinery should last for eight years. At the end of eight years, the machinery would no longer be able to produce product worthy of Woodexs manufacturing standards and would be scrapped with zero value. Production and revenue: It is estimated that Woodex would be able to sell 2,500 bats during each of the first two years of production, with sales increasing to a total of 5,000 units/year in the third and each subsequent year. Each bat should sell for INR 4500.00 the first year. For the second and following years, prices are expected to rise at the estimated Indian inflation rate of 8.8%. For simplicity, all revenues will be estimated to be received at the end of the year. Expenses: Each bat will cost USD 31.25 to produce the first year. Maintenance and other overhead expenses of USD 30,000.00 are planned for the first year. Per-unit costs and overhead expenses for the second year and beyond are expected to increase at the projected annual U.S. inflation rate of 3.9%. Overhead expenses do not include depreciation of the machinery. The machinery will be depreciated on a simplified straight-line basis for tax purposes. (depreciation is not affected by inflation). All expenses will also be estimated to come at the end of the year. Taxes: Woodex will be taxed on income in the U.S. at 35%. Woodex will also be subject to a tariff of INR 750 per bat paid to the Indian government. These tariffs are deductible for U.S. income tax purposes. Tariffs will not be subject to inflation for the estimated life of the project. As the product is not manufactured in India, there are no income or withholding taxes in India. There is also no restriction on repatriation of Indian rupee revenues converted to U.S. dollars.

Note on taxes: If operating income is negative, assume that the loss may be used to offset income from other operations. Therefore, it is possible for taxes to be negative (tax credits) in certain years. Exchange rate: Indian rupee revenues and tariffs will be converted to U.S. dollars at the estimated rate of exchange for the end of each year. The current rate of exchange is 0.01956 USD/INR Woodex projects future exchange rates using Relative Purchasing Power Parity (RPPP) and the inflation estimates given for the U.S. (3.9%) and India (8.8%). Cost of capital: Woodex estimates its weighted average cost of capital at 15% Hint: Convert revenues and tariffs (which are in rupees) to U.S. dollars before combining with other cash flows (which are already in U.S. dollars) Note: The spreadsheet example that was posted (Project Leo) may be used as a template, but be aware that a number of differences exist in the modeling of the problems. You will need to make some modifications to the existing spreadsheet to fit the nature of the data of this problem. You can, of course, create your own spreadsheet from scratch if you choose. The format is of no consequence, only the results.