10. A multinational company is planning to set up a subsidiary company in India
ID: 2335769 • Letter: 1
Question
10. A multinational company is planning to set up a subsidiary company in India (where hitherto it was exporting) in view of growing demand for its product and competition from other MNCs. The initial project cost (consisting of Plant and Machinery including installation) is estimated to be US$ 500 million. The net working capital requirements are estimated at USS 50 million. The company follows straight line method of depreciation. Presently, the company is exporting two million units every year at a unit price of US$ 80, its variable cost per unit being US$ 40 The Chief Financial Officer has estimated the following operating cost and other data in respect of proposed project: () Variable operating cost will be US $ 20 per unit of production; (ii) Additional cash fixed cost will be US $ 30 million p.a. and project's share of allocated fixed cost will be US $ 3 million p.a. based on principle of ability to share (ii) Production capacity of the proposed project in India will be 5 million units (iv) Expected useful life of the proposed plant is five years with no salvage value (v) Existing working capital investment for production & sale of two million units through exports was US $ 15 million; (vi) Export of the product in the coming year will decrease to 1.5 million units in case the company does not open subsidiary company in India, in view of the presence of competing MNCs that are in the process of setting up their subsidiaries in India (vii) Applicable Corporate Income Tax rate is 35%, and (viii) Required rate of return for such project is 12%Explanation / Answer
1 Incremental Cash Flows Cost of plant and machinery 500 Working Capital 50 Release of existing working captal -15 535 Incremental Cash infolow after tax Generated in investment in india by 5 years Sales revenue 5*80 400 Less:Costs Variable Costs 5*20 100 Fixed Cost 30 Depriciation 500/5 100 Ebit 170 Taxes @ 35% 59.5 EAT 110.5 Add:Dep 100 CFAT (1-5 years) 210.5 Release of working capital 35 Cash generated by expots Sales revenue 1.5*80 120 Less: Variable Cost (1.5*40) 60 Contribution Before tax 60 Tax@35% 21 CFAT (1-5 years) 39 Additional CFAT attributable to foreign investment Through setting up subsidiary in india 210.5 Through exports in india 39 CFAT (1-5 years) 171.5 Determination of NPV Year CFAT PVF@12% PV in million 1-5 171.5 3.6048 618.22 5 35 0.5674 19.86 638.08 Less: Initial Out flow 535 NPV 103.08 Since NPV is positive , proposal should be accepted
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