Question Details

Nebraska Co. plans to pursue a project in Argentina 


1. Financing with Foreign Equity. Orlando Co. has its U.S. business funded with dollars with a
capital structure of 60% debt and 40% equity. It has its Thailand business funded with Thai baht
with a capital structure of 50% debt and 50% equity. The corporate tax rate on U.S. earnings and
on Thailand earnings is 30%. The annualized 10-year risk-free interest rate is 6% in the U.S. and
21% in Thailand. The annual real rate of interest is about 2% in the U.S. and in Thailand. Interest
rate parity exists. Orlando pays 3 percentage points above the risk-free rates when it borrows, so
its before-tax cost of debt is 9% in the U.S. and 24% in Thailand. Orlando expects that the U.S.
annual stock market return will be 10% per year, and the Thailand annual stock market return will
be 28% per year. Its business in the U.S. has a beta of .8 relative to the U.S. market, while its
business in Thailand has a beta of 1.1 relative to the Thai market. The equity used to support
Orlando- Thai business was created from retained earnings by the Thailand subsidiary in previous
years. However, Orlando Co. is considering a stock offering in Thailand that is denominated in
Thai baht and targeted at Thai investors. Estimate Orlando- cost of equity in Thailand that would
result from issuing stock in Thailand.
2. Assessing Foreign Project Funded With Debt and Equity. Nebraska Co. plans to pursue a project in Argentina that will generate revenue of 10 million Argentine pesos (AP) at the end of
each of the next 4 years. It will have to pay operating expenses of AP3 million per year. The
Argentine government will charge a 30% tax rate on profits. All after-tax profits each year will be
remitted to the U.S. parent and no additional taxes are owed. The spot rate of the AP is presently
$.20. The AP is expected to depreciate by 10% each year for the next 4 years. The salvage value
of the assets will be worth AP40 million in 4 years after capital gains taxes are paid. The initial
investment will require $12 million, half of which will be in the form of equity from the U.S.
parent, and half of which will come from borrowed funds. Nebraska will borrow the funds in
Argentine pesos. The annual interest rate on the funds borrowed is 14%. Annual interest (and zero
principal) is paid on the debt at the end of each year, and the interest payments can be deducted
before determining the tax owed to the Argentine government. The entire principal of the loan will
be paid at the end of year 4. Nebraska requires a rate of return of at least 20% on its invested
equity for this project to be worthwhile. Determine the NPV of this project. Should Nebraska pursue the project?




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