Question
Beach Fashion Company (U.S.) is considering investing Rs60,000,000 in India to create a wholly-owned clothing manufacturing plant to export to the North American market. After
Beach Fashion Company (U.S.) is considering investing Rs60,000,000 in India to create a wholly-owned clothing manufacturing plant to export to the North American market. After five years the subsidiary would be sold to Indian investors for Rs100,000,000. A pro forma income statement for the Indian operation predicts the generation of Rs7,000,000 of annual cash flow, is listed below for years 2017 to 2021.
The initial investment will be made on December 31, 2016, and cash flows will occur on December 31 of each succeeding year. Annual cash dividends to Beach Fashion from India will equal 75% of net income. Depreciation is not repatriated. The U.S. corporate tax rate is 40% and the Indian corporate tax rate is 50%. Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to Beach Fashion will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. Beach Fashion uses a weighted average cost of capital of 14% on domestic investments, but will add 6% for the Indian investment because of perceived greater risk (20% for both the project and parent analysis).
The company forecasts the rupee/dollar exchange rate for December 31 on the next six years are listed below:
2016 R50/$, 2017 R54/$, 2018 $58/$, 2019 R62/$, 2020 R66/$, 2021 R70/$
What is the net present value and internal rate of return on this investment from both the project and parent viewpoint?
Assumptions Values Initial investment in India (Rs) Indian corporate tax rate Rs60,000,000 50.00% 100,000,000 20.00% Values Sale price in year 5 (Rs) WACC: (14% +6%=20%) Assumptions Dividend distribution per year US corporate tax rate India risk premium to WACC Pro forma income and cash flow (December 31st in Rs) 75.00% 40.00% 6.00% Year 0 2016 Years 1-5 2017-21 Sales revenue Rs 30,000,000 Less cash operating expenses (17,000,000) Gross income 13,000,000 Less depreciation expenses (1,000,000 Earnings before interest and taxes 12,000,000 Less Indian taxes at 50% (6,000,000) Net income 6,000,000 Add back depreciation 1,000,000 Annual cash flow 7,000,000Step by Step Solution
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