HepTones, Inc., is a U.S. based firm that designs andmanufactures high-end stereo speakers. They have been successfullymanufacturing and selling their speakers in the U.S. for the lastfive years. Although they are still somewhat small, their U.S.sales have been growing at a rate of 20% annually and HepTones hasachieved an excellent reputation for providing high-qualityproducts at reasonable prices. Based on their success in the U.S.,HepTones would like to expand their production and sales to Asia.Since their speakers are heavy, bulky, and somewhat delicate,exporting U.S.-made speakers to Europe appears to be too expensiveand risky.

HepTones’ Chief Financial Officer, Brenda Mendez, and her staffhave been evaluating several potential production locations inAsia. Based on Ms. Mendez’ staff’s initial assessments, Ms. Mendezhas narrowed the decision to one potential location—Delhi, India.Her decision was based on several criteria. First, average incomein India has been growing rapidly in recent decades, and a viablemarket for HepTones’ products is emerging. Second, although therehave been ups and downs, India has progressively implementedwestern-style economic, political, and business principles. Third,India’s labor force is well-educated and still relativelyinexpensive compared to other Asian countries. Finally,transportation links between India and other Asian countries arealso expanding rapidly, which bodes well for future exports toother Asian countries. Ms. Mendez has tasked you, as a financialanalyst for HepTones, with preparing a more-extensive capitalbudgeting forecast for establishing a subsidiary in the Delhilocation. She would like your recommendation as to whether thelocation is financially feasible and whether the locationaldecision is sensitive to any particular factors. She has asked youto use a 10-year forecasting horizon. Several departments atHepTones have provided you with the following information for youranalysis:

• The building and equipment needed for production in Delhi canbe acquired at a a cost of 600 million rupee. The equipment isvalued at 300 million rupee and will be depreciated usingstraight-line depreciation, which implies 30 million ofdepreciation per year for 10 years.
• Estimated sales in the first year are 30,000 pairs of speakersat a per-unit price of 45,000 rupee. Unit sales are projected toincrease at 20 percent per year in following years.
• The variable costs needed manufacture the speakers areestimated to be 40,000 per pair in the first year ofproduction.
• Fixed operating expenses, such as administrative salaries willbe 25 million rupee in the first year of operations.
• The Indian government will impose a 25 percent tax on income,and a 10 percent withholding tax on any funds remitted to the U.S.Any earnings remitted to the U.S. will not be taxed further.
• The Indian government has agreed to buy HepTones’ Indiansubsidiary after 10 years for about 700 million rupee, afterconsidering any capital gains.
• The current exchange rate for the Indian rupee is $0.015. Therupee is expected to depreciate by an average of 2 percent per yearfor the next 10 years.
• Average annual inflation in India is expected to be 10 percent.Revenues, variable costs, and fixed costs are expected to change bythe same rate as annual inflation.

HepTones’ currently uses a 20 percent rate of return to evaluatepotential investment projects in the U.S. It has decided to use a25 percent rate of return to evaluate the Indian project. Allexcess funds generated by the Indian subsidiary will be remittedback to the U.S. Do your analysis in the tab calledBaseline Scenario. After you havecompleted your analysis answer to the following question: Based onthe information provided in the case, should HepTones proceed withthe project? Why or why not? Please record your answer in theappropriate box in the tab calledQuestions. Ms. Mendez is somewhatconcerned about the project made by the marketing department thatunit sales will increase at a 20 percent annual rate. She isinterested in knowing what annual rate of increase in sales wouldmake the net present value (NPV) equal to zero. Anything less thanthis “break-even” rate of increase would mean the project is notfinancially feasible.To answer her question, make a copy of theBaseline Scenario worksheet. Rename itSensitivity Analysis. Vary the sales rateincrease until the NPV is approximately zero, and then answer thisquestion: What annual rate of increase in sales will yield an NPVof zero? Please record your answer in the appropriate box in thetab called Questions.