Natural Mosaic Company (U.S.) is considering investing Rs50,000,000 in India to
ID: 1172854 • Letter: N
Question
Natural Mosaic Company (U.S.) is considering investing Rs50,000,000 in India to create a wholly owned tile manufacturing plant to export to the European market. After five years, the subsidiary would be sold to Indian investors for Rs100,000,000. A pro forma income statement for the Indian operation predicts the generation of Rs7,000,000 of annual cash flow, is listed in the following table.
Sales revenue 30,000,000
Less cash operating expenses (17,000,000)
----------------
Gross income 13,000,000
Less depreciation expenses (1,000,000)
---------------
Earnings before interest and taxes 12,000,000
Less Indian taxes at 50% (6,000,000)
-----------------
Net income 6,000,000
Add back depreciation 1,000,000
-------------
Annual cash flow 7,000,000
The initial investment will be made on December 31, 2011, and cash flows will occur on December 31st of each succeeding year. Annual cash dividends to Philadelphia Composite from India will equal 75% of accounting income. The U.S. corporate tax rate is 40% and the Indian corporate tax rate is 50%. Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to Natural Mosaic will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. Natural Mosaic uses a weighted average cost of capital of 14% on domestic investments, but will add six percentage points for the Indian investment because of perceived greater risk. Natural Mosaic forecasts the rupee/dollar exchange rate for December 31st on the next six years are listed below.
R$/$ R$/$
(2011) 50 (2014) 62
(2012) 54 (2015) 66
(2013) 58 (2016) 70
What is the net present value and internal rate of return on this investment?
Comment:
1. You have to do this problem from the viewpoint of the parent.
Thank you,
Explanation / Answer
Yr Cash flows Rs/$ Dollar Income Discounting factor @ 20% Present Value 31-12-2011 -50000000 50 -1000000 1 -1000000 31-12-2012 2500000 54 46296.2963 0.833333 38580.25 31-12-2013 2500000 58 43103.44828 0.694444 29932.95 31-12-2014 2500000 62 40322.58065 0.578704 23334.83 31-12-2015 2500000 66 37878.78788 0.482253 18267.16 31-12-2016 102500000 70 1464285.714 0.401878 588463.6 Net Present Value -301421 Annual Cash dividends to Philadelphia Composite from India = 75% accounting income Accounting Income = 6000000*75% 4500000 Cash flow available = 6000000-4500000+1000000 2500000 Discount Rate 14%+6% 20% Assuming IRR is 10% Yr Cash flows Rs/$ Dollar Income Discounting factor @ 10% Present Value 31-12-2011 -50000000 50 -1000000 1 -1000000 31-12-2012 2500000 54 46296.2963 0.909091 42087.54 31-12-2013 2500000 58 43103.44828 0.826446 35622.68 31-12-2014 2500000 62 40322.58065 0.751315 30294.95 31-12-2015 2500000 66 37878.78788 0.683013 25871.72 31-12-2016 102500000 70 1464285.714 0.620921 909206.2 Net Present Value 43083.12 Assuming IRR is 11.0026254% Yr Cash flows Rs/$ Dollar Income Discounting factor @ 10.99% Present Value 31-12-2011 -50000000 50 -1000000 1 -1000000 31-12-2012 2500000 54 46296.2963 0.90088 41707.39 31-12-2013 2500000 58 43103.44828 0.811584 34982.07 31-12-2014 2500000 62 40322.58065 0.73114 29481.43 31-12-2015 2500000 66 37878.78788 0.658669 24949.57 31-12-2016 102500000 70 1464285.714 0.593381 868879.5 Net Present Value 0.00 The Net Present Value will be -$301421 and IRR would be approx 11.0026%
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