Recall Blades Inc. is a famous producer of Speedos and hastentatively decided to establish a subsidiary in Thailand to manufacture rollerblades. The new plant will be operated for 10 years and expected to be soldafter that. Furthermore, forecasts for the future value of the THB indicatethat the currency may continue to depreciate in the future.
At a recent meeting of the board of directors, the CFO of thecompany Mr. Holt presented his capital budgeting analysis. TheCFO demonstrated that the establishment of a subsidiary in Thailand had a netpresent value (NPV) of about $8 million with a 25 % required rate ofreturn.
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Additionally, after establishing a subsidiary in Thailand 10% ofthe companys total capital will be allocated to a Thailand subsidiary. Inorder to avoid the effect of the exchange rate movement on WACC calculationsthe company enters in a one-year forward contract which ensures converting THBback to USD at the end of the fiscal year will be the same as the rate at thebeginning of the same fiscal year. The cost of entering forward contact of theexpected cash flow back to the US at the end of the fiscal year is assumed as5%, which will increase the WACC by some %.