M Company is considering whether to establish a sale distribution center in Chin

Question

M Company is considering whether to establish a sale distribution center in China. Given the large Chinese consumer market, M company estimates that its net sales revenues will be 15 million yuans in the first year, 20 million yuans in the second year, and 35 million yuans in the third year. The current spot rate is 6 yuans per US dollar.

The project is assumed to have a beta of 1. The Chinese market risk premium is 10%, and U.S. market risk premium is 6%. The risk free rate is assumed to be 6%. M company’s initial investment outlay, consisting of plant and equipment, is estimated at 12 million yuans, and the plant and equipment will be depreciated on a straight-line basis over a three-year period, with salvage value of 2 million yuans. The corporation tax rate is 25% in China and 35% in the US.

Should M company establish the distribution center?

Explanation / Answer

Cashflow Projection (Amount in Yuan) Particulars Year 1 Year 2 Year 3 Opening Balance 0.00 -1000000.00 15000000.00 Sales Revenue 15000000.00 20000000.00 35000000.00 Less: Plant & Equip 12000000.00 0.00 0.00 Less:Depreciation 4000000.00 4000000.00 4000000.00 Add: Salvage Value 0.00 0.00 2000000.00 Earning Before Tax -1000000.00 15000000.00 48000000.00 Less: Tax @ 25% 0.00 3750000.00 12000000.00 Profit After Tax -1000000.00 11250000.00 36000000.00

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