Natural Mosaic. Natural Mosaic Company (U.S.) is considering investing Rs50,000,000 in India to create a wholly owned tile manufacturing plant to export to the European 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 in the following table.

Sales Revenue 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 7,000,000

The initial investment will be made on December 31, 2011, and cash flows will occur on December 31^st of each succeeding year. Annual cash dividends to Philadelphia Composite from India will equal 75% of accounting income.

The U.S. corporate tax rate is 40% and the Indian corporate tax is 50%. Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to Natural Mosaic will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. Natural Mosaic uses a weighted average cost of capital of 14% on domestic investments, but will add six percentage points for the Indian investment because of perceived greater risk. Natural Mosaic forecasts the rupee/dollar exchange rate for December 31^st on the next six years are listed below.

R$/$ R$/$

2011 50 2014 62

2012 54 2015 66

2013 58 2016 70

What is the net present value and internal rate of return on this investment?

Here is my answer:

The information that is already given above includes:

Initial Investment (Rs)	50,000,000
Indian Corporate Tax Rate	50%
Sale Price in Year 5 (Rs)	100,000,000
Natural Mosaic Companys WACC	14%
Dividend Distribution Per Year	75%
U.S. Corporate Tax Rate	40%
Indias Risk Premium to WACC	6%

From the project viewpoint, the net present value (NPV) can be calculated by first determining the cash flows from 2011 to 2016. Beside the annual cash flow given in the income statement above, the initial investment and the sale price also need to be considered as cash flows:

2011 -50,000,000

2012 7,000,000

2013 7,000,000

2014 7,000,000

2015 7,000,000

2016 7,000,000 + 100,000,000 = 107,000,000

Pro Forma Income and Cash Flow

Year	Cash Flows	PV Factor at 20%	PV
2011	-50,000,000	1/(1.2)0 = 1.0000	-50,000,000
2012	7,000,000	1/(1.2)1 = .8333	5,833,333.333
2013	7,000,000	1/(1.2)2 = .6944	4,861,111.111
2014	7,000,000	1/(1.2)3 = .5787	4,050,925.926
2015	7,000,000	1/(1.2)4 = .4823	3,375,771.605
2016	107,000,000	1/(1.2)5 = .4019	43,000,900.21
			11,122,042.19

The NPV of the project viewpoint (investment in India) is $11,122,042

The IRR of the project viewpoint (investment in India) is 25.96%

Given the Current Exchange Rate (Rs/$):

Rs/$ in 2011 50

Rs/$ in 2012 54

Rs/$ in 2013 58

Rs/$ in 2014 62

Rs/$ in 2015 66

Rs/$ in 2016 70

From the parent companys viewpoint, the net present value (NPV) and the internal rate of return (IRR) can be computed by first calculating the dividends received in the U.S. each by multiplying the net income from the income statement times the dividend distribution per year:

6,000,000 x .75 = 4,500,000

The next step is determining the cash flows for each year (from 2011-2016):

2011 4,500,000

2012 4,500,000

2013 4,500,000

2014 4,500,000

2015 4,500,000

2016 4,500,000 + 100,000,000 = 104,500,000

Using the Current Exchange Rate, convert the cash flows to the U.S. $:

Convert the cash flow in U.S. dollars:

2011: -50,000,000Rs x 1US$/50R$ = -$1,000,000

2012: 4,500,000Rs x 1US$/54R$ = $83,333

2013: 4,500,000Rs x 1US$/58$ = $77,586

2014: 4,500,000Rs x 1US$/62$ = $72,581

2015: 4,500,000Rs x 1US$/66R$ = $68,182

2016: $104,500,000Rs x 1US$/70R$ = $1,492,857

Now, calculate NPV:

Year	Cash Flows	PV Factor at 20%	Present Value
2011	-1,000,000	1/(1.2)0 = 1.0000	-1,000,000
2012	83,333	1/(1.2)1 = .8333	69,444.16667
2013	77,586	1/(1.2)2 = .6944	53,879.16667
2014	72,581	1/(1.2)3 = .5787	420,002.89352
2015	68,182	1/(1.2)4 = .4823	32,880.97994
2016	1,492,857	1/(1.2)5 = .4019	599,945.7465
			-201,847.0467

The NPV of the project (parent viewpoint) is -$201,847.05

The IRR of this project (parent viewpoint) is 13.94%

The NPV of the project is -$201,847.05 < 0 so reject the proposed investment because the project is expected to generate less than the companys required rate of return.

These are my questions:

1. Why is PV factor at 20%?

2. What is the project required rate of return for both project viewpoint and parent viewpoint

3. How do you find NPV and IRR on financial calculator

4. Do we accept or reject IRR of 13.94%. Why?