8. Vande The following information has been gathered to assess this project: The

Question

8. Vande The following information has been gathered to assess this project: The initial investment required is SGD 10 million. The current spot rate is .73 USD/SGD ·The project will be terminated at the end of Year 2, when the subsidiary will be sold. .The price, demand, and variable cost of the product in the Singapore are as follows: lay Corporation presently has an existing business in Singapore but is considering an additional plant there. Year Price Demand Variable cost 1 SGD 25 550,000 SGD 10 2 SGD 20 600,000 SGD 8 .The exchange rate is forecasted to be .71 USD/SGD at the end of Year 1, and.70 USD/SGD at the end of year 2. ·The Singapore government will impose an income tax of 20% on income. In addition, the US. government will impose a tax of 10% on earnings remitted by the subsidiary (ignore tax credits). Singapore imposes a 10% withholding tax on all remittances to foreign countries. All cash flows received by the subsidiary are sent to the parent at the end of each year. ·The annual depreciation expense is 15% of initial outlay. In two years the subsidiary is to be sold. Vandelay expects to receive SGD 1.5 million. This amount will be taxed at the usual withholding rate in Singapore. (But, it will not be taxed in the US. at the 10% rate.) . Vandelay requires a 12% rte of return on this project. (i) Calculate the NPV from the perspective of the subsidiary. (ii) Calculate the NPV from the perspective of the parent. (iii) Should Vandelay accept this project?

Explanation / Answer

(i) Computation of the NPV from the perspective of the subsidiary.We have,

Step1: Computation of the present value of cash inflow.We have,

Note: Sale value of subsidiary = 1,500,000 (1 - 0.10) = SGD 1,350,000 (10% withhelding tax apply on sale of subsidiary)

Total present value of free cash flow = 6,161,700 +  5,905,770 = SGD 12,067,470

Step2: Computation of the NPV of the project.We have,

NPV = Present value of cash inflow - Cash outflow

NPV = 12,067,470 - 10,000,000 = SGD 2,067,470

Hence, the NPV from the perspective of the subsidiary is SGD 2,067,470

(ii) Computation of the NPV from the perspective of the parent.We have,

Step1: Cash outflow in $ for the parent company.We have,

Current spot rate:

1 SGD = 0.73 $

Cash outflow in $ = 10,000,000 x 0.73 = $ 7,300,000

Step2; Cash inflow is $ for parent company for two years.We have,

Since, the US goverment impose 10% all earning which is remitted by subsidiary and Singapore impose 10 % withhelding tax on all remittances to foreign country.

For First year:

First year exchange rate:

1 SGT = 0.71 $

Cash inflow for the first year in $ = 6,900,000 x 0.71 = $ 4,899,000

Total cash remittance to parent company in the first year =  4,899,000 x( 1- 0.10) x (1 - 0.10) = $ 3,968,190

Present Value of cash remittance to parent company in the first year = $ 3,968,190 x 0.893

= $ 3,543,594

For Second year:

Second year exchange rate:

1 SGT = 0.70 $

Cash inflow for the second year in $ = (6,060,000 x 0.70) + (1,500,000 x 0.70)

= 4,242,000 + 1,050,000 = $ 5,292,000

Total cash remittance to parent company in the second year = 4,242,000 x( 1- 0.10) x (1 - 0.10) + 1,050,000 (1 - 0.10) = 3,436,020 + 945,000 = $ 4,381,020

(Since, sale of subsidiary amount is exempt by US government.)

Present Value of cash remittance to parent company in the second year = $ 4,381,020x 0.797

= $ 3,491,673

Present value of total cash inflow to parent company = 3,543,594 + 3,491,673 = $ 7,035,267

Step3: Computation of NPV for the parent company.We have,

NPV = Present value of total cash inflow - Cash outflow

NPV = 7,035,267 - 7,300,000 = - $ 264,733

Hence, the NPV from the perspective of the parent shall be  - $ 264,733

(iii)

If net present value(NPV) of the project has positive value,then project should be accepted.In this question, NPV from the perspective of subsidiary has positive value( SGD 2,067,470).But, NPV from the perspective of parent company has negative value(- $ 264,733). Therefore, the project should not be accepted.

Year 1 2 Sale price per unit 25.00 20.00 Less: Variable cost per unit 10.00 8.00 Contribution margin per unit 15.00 12.00 Number of unit sold 550,000 600,000 Total Contribution 8,250,000 7,200,000 Less: Depreciation expenses 1,500,000 1,500,000 Earning before taxes 6,750,000 5,700,000 Less: Tax expenses(20%) 1,350,000 1,140,000 Profit after taxes 5,400,000 4,560,000 Add: Depreciation 1,500,000 1,500,000 Add: Sale value of subsidiary 0 1,350,000 Free Cash flow 6,900,000 7,410,000 PVF(12%) 0.893 0.797 Present value of free cash flow 6,161,700 5,905,770

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