4. Capital Budgeting Problem

Pepsi-Cola is planning on opening a subsidiary in India. The subsidiary will cost Rupees 1 billion; working capital needs of the subsidiary include an increase in inventories of Rupees 200 million, and increase in accounts payables to the tune of Rs. 300 million. The revenues from the subsidiary are estimated to be Rupees 800 million per year over a 5-year economic life. Depreciation expense after accounting for the savage value of Rs. 200 million will be Rupees 160 million/year. Total costs (fixed and variable costs together) will be Rupees 250 million/year. The plant will have a salvage value of Rupees 200 million (net of taxes) in the terminal year. Indian government imposes a 30% tax on earnings. 100% of the cash flows will be remitted to the parent. However, there will be a 10% withholding tax by the Indian Govt. Pepsi-Cola requires 14% return on new investments of this kind in developing countries. The exchange rate is expected to be stable at Rupees 65/$.

a) Calculate the net investment cost (US $) of the subsidiary.

b) Calculate after-tax cash flows in US $ for years 1 through 5

c) Calculate the Net Present Value (NPV) of the project.

d) Calculate the IRR of the project

e) Should the project be accepted or rejected?

f) Now, recalculate the NPV & decide whether the project should be accepted or rejected under the following scenarios:

i) Strong Rupee: Rs. 60/ US $

ii) Weak Rupee: Rs. 70/ US $