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Quiestion;

Oriental construction firm is a manufacturer of window frames. Its main UK manufacturing operation is based in the North of England,

from where it distributes its products throughout the UK$.$ The directors are now considering whether they should open up an

additional manufacturing operation in France $-$ which they believe there will be a good market for their products. A suitable factory

has been located just outside Paris that could be rented on a $5-$year lease at an annual charge of $1\mathrm{.}9m,$ payable each year in

advance.

The manufacturing equipment would cost $37\mathrm{.}5m,$ of which $30m$ would have to be paid at the start of the project, with the balance

payable $12$ months later. At the start of each year the French factory would require working capital equal to $20\%$ of that year's sales

revenues. It is expected that the factory will be able to produce and sell $40,000$ window units per year although, in the first year,

because of the need to 'run in$\text{'}$ the machinery and its new workforce, output is only expected to be $25,000$ window units. Each

window is likely to be sold for $375,$ a price that represents a $150\%$ mark up on cash production costs. The French factory would be

set up as a wholly$-$owned subsidiary of Oriental. In France, $25\%$ straight$-$line depreciation on cost is an allowable expense against

company tax. Corporation tax is payable at $40\%$ at each year$-$end without delay and any unused losses can be brought forward for

set off against the following year's profits. No UK tax would be payable on the after$-$tax French profits. All amounts in $$ are given in

current terms. Annual inflation in France is expected to run at $6\%$ per year in the foreseeable future. All $$ cash flows involved are

expected to increase in line with this inflation rate, with the exception of the factory rental and the cost of the manufacturing

equipment, both of which would remain unchanged. The French factory would be producing windows to a special design patented by

Oriental. To protect its patent rights, Oriental will charge its French subsidiary a fixed royalty of $10$ per window. This cost would be

allowable against the subsidiary's French tax liability. The current $\frac{}{}1$ spot rate is $1\mathrm{.}5.$ Inflation in the UK is expected to be $4\%$ per

year over the period. There are no remittance restrictions between France and the UK$.$

Oriental is an all$-$equity financed company that is quoted on the London Stock Exchange. Its shares have a beta value of $1\mathrm{.}25.$ The

current annual return on UK Government Treasury Bills is

$10\%$ and the expected return on the market is $18\%.$ In the UK Corporation Tax is payable at $35\%,$ one year in arrears. Oriental

operates on a $5-$year planning horizon. At the end of five years, assume that working capital would be fully recovered and the

production equipment would have a scrap value, at that time, of $35m$ before tax. Proceeds on asset sales are taxed at $40\%.$

Assume all cash flows arise at the end of the year to which they relate, unless otherwise stated.

Required:

Evaluate the proposed investment in France and recommend what investment decision should be made by Oriental firm. State

clearly any assumptions you make and work all calculations rounded to nearest $10,000($either $$ or $)-$ i$.$e$.0\mathrm{.}01m$ or

Marks$)$

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