Question

Decision by Blades, Inc., to Invest in Thailand

Since Ben Holt, Blades’ chief financial officer, believes the growth potential for the roller blade market in Thailand is very high, he 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 subsidiary.
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.
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 next year.
¦ Blades’ fixed operating expenses, such as administrative salaries, will be 25 million baht next year. ¦ 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 10 years.
¦ 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.
Holt has asked you to answer the following questions:
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 these conditions?

Answer 1

A thorough financial analysis for Blades, Inc. considering the investment in a Bangkok subsidiary should include costs, depreciation, tax implications, inflation, and potential currency fluctuations. It is crucial to evaluate both the current market and long-term economic outlook, and conduct sensitivity analyses to make an informed decision on the investment in Thailand.

Step-by-step explanation:

The decision by Blades, Inc. to invest in Thailand and establish a subsidiary in Bangkok is primarily influenced by the high growth potential for the roller blade market in the country.

The chief financial officer of Blades, Ben Holt, believes that economic conditions in Thailand will be strong in 10 years when the company expects to sell the subsidiary.

The capital budgeting analysis must take into consideration various factors such as the cost of building and equipment, depreciation, variable and fixed costs, the effect of inflation, tax implications, and the projected changes in the exchange rate between the Thai baht and the US dollar.

One important aspect of this analysis is to acknowledge the potential risk of currency fluctuation, as highlighted by the scenarios where the baht weakens or strengthens against the dollar. Such fluctuations can significantly impact the financial feasibility of the project.

For instance, if the Thai baht depreciates more than expected against the dollar over the next 10 years, the value of the subsidiary, when converted back into dollars, would be less than anticipated, potentially affecting the profitability of the investment.

Furthermore, the calculation of annual depreciation, the benefits of reduced variable costs by manufacturing locally, and the expected sale price of the subsidiary after 10 years will play a crucial role in the decision-making process.

Conducting sensitivity analyses for different scenarios involving exchange rate changes and other uncertainties will help Blades to better assess the potential risks and returns of the investment.

Overall, the decision to establish a subsidiary in Thailand should be influenced by a thorough financial analysis that evaluates the potential risks and benefits, considering both current market conditions in Bangkok's business district and the long-term economic outlook for Thailand.