QUESTION: Estimate the Cash flows for parent and calculate NPV and IRR for the parent. Shall the parent company accept the project?

INFO BELOW:

Elaine Corporation plans to expand its current operation to Switzerland. The following information has been gathered to assess this project:

• The initial investment required is CHF 7 million. The current spot rate is 0.52 USD/CHF.
• The project will be terminated at the end of Year 2, when the subsidiary will be sold.
• Elaine is planning on taking a CHF 1.0 million loan from Switzerland banking system for 5 years. The interest on the loan is 6% and the annual interest expense is CHF 60,000. The principal amount will be repaid end of the term as a lump sum. Also assume that Swiss subsidiary will not require any additional working capital.
• The following information is available for the analyst:

• The Swiss government will impose an income tax of 20% on income. The US corporate income tax is 35%.
• All cash flows received by the subsidiary are sent to the parent at the end of each year. The Swiss government will impose 5% withholding tax.
• In two years the subsidiary is to be sold. Elaine expects to receive CHF 750,000 which is subject to withholding tax in Switzerland.
• Elaine requires a 15% rate of return on this project also use the same discount rate for valuing subsidiarys cash flow.

Partial Pro-forma Income Statement for Subsidiary (in CHF) Year o 0.52 Exchange Rate (USD/CHF) Sales Revenue Depreciation EBIT EBT Tax (20%) Net Income Year 1 0.50 15,000,000 1,050,000 7,450,000 7,390,000 1,478,000 5,912,000 Year 2 0.45 19,200,000 1,050,000 11,250,000 11,190,000 2,238,000 8,952,000 Partial Pro-forma Income Statement for Subsidiary (in CHF) Year o 0.52 Exchange Rate (USD/CHF) Sales Revenue Depreciation EBIT EBT Tax (20%) Net Income Year 1 0.50 15,000,000 1,050,000 7,450,000 7,390,000 1,478,000 5,912,000 Year 2 0.45 19,200,000 1,050,000 11,250,000 11,190,000 2,238,000 8,952,000