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Question Eight: Capital Budgeting Read the hypothetical case below and answer the questions that follow. Lexington Corp., a U.S. firm, currently has no existing business in New Zealand but is considering establishing a subsidiary there to serve the local market there. The following information has been gathered to assess this project. The initial investment required is 20 million New Zealand dollars (NZ$). The project will be terminated at the end of year 5, when the subsidiary will be sold. The current spot rate of the New Zealand dollar is quoted as: USD/NZD = 0.6712 and for now it is assumed to remain constant until the end of the project. The after-tax earnings of the subsidiary are estimated to be NZ$1,500,000; NZ$2,750,000 NZ$3,900,000; NZ$5,000,000 and NZ$6,250,000 at the end of years one, two, three, four, and five respectively. The New Zealand government will impose a withholding tax of 10 percent on remitted earnings by the subsidiary. All cash flows received by the subsidiary are to be sent to the parent at the end of each year. The salvage value to be received is NZ$10 million. Lexington requires an 15% rate of return on this project. Questions: 1) Calculate the net present value of this project. Should Lexington accept this project? 2) Suppose that the New Zealand dollar depreciated continuously against the U.S. dollar by 2% annually until the end of year 5. What will be the effect on Lexington project's NPV? Comment on your results. What could be done to face this possible scenario? 3) Go back to the original scenario again, but now assume that funds are blocked until the subsidiary is sold and funds are reinvested at a rate of 4% annually until they are remitted by the end of Year 5. Show how the project's NPV is affected. Comment on your

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