Brighteyes plc manufactures medical and optical equipment for both domestic and export sale. It is investigating the construction of a manufacturing plant in Lastonia, a country in the former Soviet bloc. Initial discussions with the Ministry of Economic Development in Lastonia have met with favourable response, providing the project can generate a 10 per cent pre-tax return. Shareholders look for a return of 15 per cent in real terms.

The investment will be partly import-substituting and partly export-based, selling to neighbouring countries.

The project has been offered a local tax holiday, exempting it from all taxes for the first 10 years, except for cash remittances, for which a 20 per cent withholding tax will apply. Modern factory premises on an industrial estate with convenient road and rail links have been offered at a reasonable rent.

The initial investment will be £10 million in plant, machinery and set-up costs, all payable in sterling by the parent company. Additional funds will come from a bank loan of 20 million latts, the local currency (4 latts = £1), negotiated with a local bank, at a concessionary rate of interest of 10 per cent p.a. This will be used to finance working capital. Operating cash flows, the basis for calculating tax, are estimated at L10 million in Year 1 and L22 million thereafter until Year 5.

The whole of the parent’s earnings after payment of local interest and taxation will be repatriated to the United Kingdom. The Lastonia withholding tax is to be allowed as a deduction before calculating the UK Corporation Tax, currently at the rate of 30 per cent. All transfers can be treated as occurring on the final day of each accounting period, when all taxes become due.

The new venture is expected to ‘cannibalise’ exports that Brighteyes would otherwise have made to neighbouring countries, resulting in post-tax cash flow losses of £0.5 million in each of Years 2 to