Since Ben Holt, Blades’ chief financial officer (CFO),
believes the growth potential for the roller blade market
in Thailand is very high, he, together with Blades’
board of directors, has decided to invest in Thailand.
The investment would involve establishing a subsidiary
in Bangkok consisting of a manufacturing plant to produce
Speedos, Blades’ high-quality roller blades. Holt
believes that economic conditions in Thailand will be
relatively strong in 10 years, when he expects to sell the
Blades will continue exporting to the United Kingdom
under an existing agreement with Jogs, Ltd., a
British retailer. Furthermore, it will continue its sales
in the United States. Under an existing agreement with
Entertainment Products, Inc., a Thai retailer, Blades is
committed to selling 180,000 pairs of Speedos to the
retailer at a fixed price of 4,594 Thai baht per pair.
Once operations in Thailand commence, the agreement
will last another year, at which time it may be renewed.
Thus, during its first year of operations in Thailand,
Blades will sell 180,000 pairs of roller blades to Entertainment
Products under the existing agreement
whether it has operations in the country or not. If it
establishes the plant in Thailand, Blades will produce
108,000 of the 180,000 Entertainment Products
Speedos at the plant during the last year of the agreement.
Therefore, the new subsidiary would need to
import 72,000 pairs of Speedos from the United States
so that it can accommodate its agreement with Entertainment
Products. It will save the equivalent of 300
baht per pair in variable costs on the 108,000 pairs
not previously manufactured in Thailand.
Entertainment Products has already declared its
willingness to renew the agreement for another 3
years under identical terms. Because of recent delivery
delays, however, it is willing to renew the agreement
only if Blades has operations in Thailand. Moreover,
if Blades has a subsidiary in Thailand, Entertainment Products will keep renewing the existing agreement as
long as Blades operates in Thailand. If the agreement is
renewed, Blades expects to sell a total of 300,000 pairs
of Speedos annually during its first 2 years of operation
in Thailand to various retailers, including 180,000 pairs
to Entertainment Products. After this time, it expects to
sell 400,000 pairs annually (including 180,000 to Entertainment
Products). If the agreement is not renewed,
Blades will be able to sell only 5,000 pairs to Entertainment
Products annually, but not at a fixed price. Thus,
if the agreement is not renewed, Blades expects to sell a
total of 125,000 pairs of Speedos annually during its
first 2 years of operation in Thailand and 225,000
pairs annually thereafter. Pairs not sold under the contractual
agreement with Entertainment Products will be
sold for 5,000 Thai baht per pair, since Entertainment
Products had required a lower price to compensate it
for the risk of being unable to sell the pairs it purchased
Holt wishes to analyze the financial feasibility of
establishing a subsidiary in Thailand. As a Blades’
financial analyst, you have been given the task of analyzing
the proposed project. Since future economic
conditions in Thailand are highly uncertain, Holt has
also asked you to conduct some sensitivity analyses.
Fortunately, he has provided most of the information
you need to conduct a capital budgeting analysis. This
information is detailed here:
■ The building and equipment needed will cost
550 million Thai baht. This amount includes
additional funds to support working capital.
■ The plant and equipment, valued at 300 million
baht, will be depreciated using straight-line
depreciation. Thus, 30 million baht will be
depreciated annually for 10 years.
■ The variable costs needed to manufacture
Speedos are estimated to be 3,500 baht per pair
■ Blades’ fixed operating expenses, such as
administrative salaries, will be 25 million baht
■ The current spot exchange rate of the Thai baht
is $.023. Blades expects the baht to depreciate by
an average of 2 percent per year for the next
■ The Thai government will impose a 25 percent
tax rate on income and a 10 percent withholding
tax on any funds remitted by the subsidiary to
Blades. Any earnings remitted to the United States
will not be taxed again.
■ After 10 years, Blades expects to sell its Thai
subsidiary. It expects to sell the subsidiary for
about 650 million baht, after considering any
capital gains taxes.
■ The average annual inflation in Thailand is
expected to be 12 percent. Unless prices are
contractually fixed, revenue, variable costs, and
fixed costs are subject to inflation and are
expected to change by the same annual rate as
the inflation rate.
Blades could continue its current operations of
exporting to and importing from Thailand, which
have generated a return of about 20 percent. Blades
requires a return of 25 percent on this project in
order to justify its investment in Thailand. All excess
funds generated by the Thai subsidiary will be remitted
to Blades and will be used to support U.S. operations.
Holt has asked you to answer the following questions:
1. Should the sales and the associated costs of
180,000 pairs of roller blades to be sold in Thailand
under the existing agreement be included in the capital
budgeting analysis to decide whether Blades should
establish a subsidiary in Thailand? Should the sales
resulting from a renewed agreement be included? Why
or why not?
2. Using a spreadsheet, conduct a capital budgeting
analysis for the proposed project, assuming that Blades
renews the agreement with Entertainment Products.
Should Blades establish a subsidiary in Thailand under
3. Using a spreadsheet, conduct a capital budgeting
analysis for the proposed project assuming that Blades
does not renew the agreement with Entertainment
Products. Should Blades establish a subsidiary in
Thailand under these conditions? Should Blades renew
the agreement with Entertainment Products?
4. Since future economic conditions in Thailand are
uncertain, Holt would like to know how critical the
salvage value is in the alternative you think is most
5. The future value of the baht is highly uncertain.
Under a worst-case scenario, the baht may depreciate
by as much as 5 percent annually. Revise your
spreadsheet to illustrate how this would affect Blades’
decision to establish a subsidiary in Thailand. (Use the
capital budgeting analysis you have identified as the
most favorable from questions 2 and 3 to answer this
Since multiple questions are asked question 1 is answered below:
1. The sales from the existing agreement should not be included in the capital budgeting analysis to decide whether Blades should establish a subsidiary in Thailand. Blades will generate these sales whether or not it establishes a subsidiary in Thailand.
The cost savings of 300 Thai baht per pair of roller blades for the 180,000 pairs not previously sourced from Thailand should be included in the capital budgeting analysis, as these savings would not occur if Blades continued to import from Thailand.
The sales resulting from the renewed agreement should be included in the capital budgeting analysis, because Entertainment Products will not renew the agreement if Blades simply continues to export to Thailand.
Thus, this revenue is incremental to the establishment of a subsidiary.
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