Firm DFG plans to open a foreign subsidiary through which to sell its manufactured goods in the European market. It must decide between locating the subsidiary in Country X or Country Z. If the subsidiary operates in Country X, its gross receipts from sales will be subject to a 3 percent gross receipts tax. If the subsidiary operates in Country Z, its net profits will be subject to a 42 percent income tax. However, Country Z€™s tax law has a special provision to attract foreign investors: No foreign subsidiary is subject to the income tax for the first three years of operations. DFG projects the following annual operating results for the two locations (in thou-sands of dollars).

DFG projects that it will operate the foreign subsidiary for 10 years (years 0 through 9) and that the terminal value of the operation at the end of this period will be the same regardless of location. Assuming a 5 percent discount rate, determine which location maximizes the NPV of the foreign operation.

Transcribed Image Text:

CountryX Country Gross receipts from sales Cost of sales Operating expenses Net profit S110,000 (60,000) (15.000) S 35,000 S110,000 (60,000) $ 28,000