Question
Elvis Inc. is planning to establish a subsidiary in Australia to produce canola oil. The manufacturing facility will cost the parent company an initial investment
Elvis Inc. is planning to establish a subsidiary in Australia to produce canola oil. The manufacturing facility will cost the parent company an initial investment of 5 million U.S. dollars (US$) to set up. The project will end in 3 years. At the end of the project, Elvis will sell the Australian subsidiary for A$8 million to an Australian agriculture firm. This amount is net of capital gain tax and is not subject to the withholding tax. Elvis estimates the after-tax net cash flows are A$6,400,000, A$3,000,000, and A$5,900,000 at the end of the first, second and third year, respectively. The Australian government will impose a corporate tax of 27% and a withholding tax of 19% on remitted funds. Additionally, the Australian law requires the subsidiary to operate locally at least for 3 years before it can remit earnings to its parent company. The parent's required rate of return for the Australian project is 10%. Suppose that the subsidiary can invest at 5% p.a. in Australia throughout the project duration and the exchange rate for the Australian dollar would remain unchanged at $0.141 throughout the project duration. Conduct a capital budgeting analysis to determine the feasibility of this project by completing the table below.
Year 0 | Year 1 | Year 2 | Year 3 | ||
1 | Before-tax earnings of subsidiary (A$) | ||||
2 | Host government tax (A$) | ||||
3 | After-tax earnings of subsidiary (A$) | ||||
4 | A$ Net cash flow to subsidiary | ||||
5 | A$ remitted by subsidiary (100% of net cash flow) | ||||
Reinvested fund from year 1 | |||||
Reinvested fund from year 2 | |||||
5a | Accumulated A$ | ||||
6 | Withholding tax on remitted funds | ||||
7 | A$ remitted after withholding tax | ||||
8 | Salvage value | ||||
9 | Exchange rate | ||||
10 | Cash flows to parent | ||||
11 | PV of parent cash flows | ||||
12 | Initial investment (US$) | ||||
13 | Cumulative NPV (US$) |
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