h plc has estimated the potential cash flows that would arise if they were successful in taking over one of their French customers, Trendy Limited. Following the proposed takeover, Trendy Limited would become Cloth (France), a subsidiary of Cloth plc. Cloth (France)’s functional currency would be the Euro. The estimated cash flows for the project are given below and management considers that a discount rate of 10% reflects the riskiness of the project. Cloth plc is planning to repatriate all net cash flows generated by the subsidiary at the end of each year in the form of an annual dividend payment. Year 0 Year 1 Year 2 Year 3 Total cash inflows (Euro million) 0 30 22 21 Total cash outflows (Euro million) 30 16 11 10 Decrease in cash inflows (£ million) (0) (2) (4) (4) Forecasted exchange rate £1/€1.2 £1/€1.2 £1/€1.15 £1/€1.15 Required:
Cloth plc has estimated the potential cash flows that would arise if they were successful in taking over one of their French customers, Trendy Limited. Following the proposed takeover, Trendy Limited would become Cloth (France), a subsidiary of Cloth plc.
Cloth (France)’s functional currency would be the Euro. The estimated cash flows for the project are given below and management considers that a discount rate of 10% reflects the riskiness of the project. Cloth plc is planning to repatriate all net cash flows generated by the subsidiary at the end of each year in the form of an annual dividend payment.
Year 0 Year 1 Year 2 Year 3
Total
Total
Decrease in cash inflows (£ million) (0) (2) (4) (4)
Required:
a) Calculate the
b) Discuss whether subsequent projects undertaken by Cloth (France) should be evaluated from the French subsidiary’s perspective or from the perspective of Cloth plc. Explain the additional factors that should be considered when evaluating projects undertaken by a foreign subsidiary as opposed to a purely domestic project.
c) Explain why the following can be considered as strategic options in capital investment appraisal and why they might add value.
i. Ability to abandon a project
ii. Ability to defer a project
iii. Ability to expand in the future
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