In: Finance
Steele Corp., a U.S. company, plans to establish a subsidiary in Australia. An initial investment of A$53 million is required for the Australian subsidiary. The Australian government will impose a withholding tax of 12 percent on earnings remitted by the Australian subsidiary. Steele is subject to 35 percent corporate tax in the U. S. As for Steele’s subsidiary in Australia, it is subject to 30 percent corporate tax rate. The U.S. government will not impose any taxes on the A$ income. At the end of year 3, the Australian subsidiary expects to receive a salvage value of A$45 million after subtracting capital gains taxes. This amount is not subject to a withholding tax by the Australian government.
For the Australian subsidiary, Steele uses its cost of capital as the project’s discount rate. Steele’s capital structure is 40 percent debt and 60 percent equity. The after-tax cost of debt and equity for Steele are 10 percent and 25 percent, respectively. The table below provides the relevant information for Steele Corp. at the end of each corresponding year:
Now |
Year 1 |
Year2 |
Year 3 |
|
Initial outlay (A$) |
53,000,000 |
|||
Cash remitted back (A$) |
8,500,000 |
12,000,000 |
15,920,000 |
|
Salvage value (A$) |
45,000,000 |
|||
Exchange rate estimates ($/A$) |
0.50 |
0.52 |
0.54 |
0.56 |
Forward rate |
0.50 |
0.545 |
0.55 |
Required:
Information given in question | Amounts in Aust. A$ | ||||
Initial Outlay for Autralian Sbusidiary | 5,30,00,000 | ||||
Withholding Tax in Australia | 12% | ||||
Corporate tax in US | 35% | ||||
Corporate tax in Aust. | 30% | ||||
Salvage value at the end of year 3 | 4,50,00,000 | ||||
Capital Structure | Debt | 40% | |||
Equity | 60% | ||||
After tax Cost of: | Debt | 10% | |||
Equity | 25% |
Working Notes | |||||
Calculation of WACC | |||||
Capital Struture (a) | Cost of capital (b) | (a)x(b) | |||
Debt | 40% | 10% | 4.00% | ||
Equity | 60% | 25% | 15.00% | ||
WACC | 19.00% | ||||
Calculation of Depreciation | |||||
Depreciation = Project cost-Salvage Value/Number of years | |||||
Project Cost | 5,30,00,000 | ||||
Salvage Value | 4,50,00,000 | ||||
80,00,000 | |||||
No. of Years | 3 | ||||
Depreciation/Year | 26,66,667 | ||||
Calculation of Interest | |||||
40% of the project is Debt financed | |||||
So 40% of 53000000 is | 2,12,00,000 | ||||
After tax Interest cost | 10% | ||||
Tax rate (USA) | 35% | ||||
Before Tax Interest Cost | 15% | (Rounded Off) | |||
Before tax Interest | 31,80,000 | (p.a) |
Solution | ||||||||
Year 1 | Year 2 | Year3 | year 3 | |||||
1 | Cash remmitence | 85,00,000 | 1,20,00,000 | 1,59,20,000 | ||||
2 | Depreciation | 26,66,667 | 26,66,667 | 26,66,667 | ||||
3 | Interest | 31,80,000 | 31,80,000 | 31,80,000 | ||||
4 | EBT | 26,53,333 | 61,53,333 | 1,00,73,333 | ||||
5 | Corporate tax @ 30%(4x5) | 7,96,000 | 18,46,000 | 30,22,000 | ||||
6 | EAT(4-5) | 18,57,333 | 43,07,333 | 70,51,333 | ||||
7 | Add back Depreciation(6+2) | 26,66,667 | 26,66,667 | 26,66,667 | ||||
8 | Cash inflow(6+7) | 45,24,000 | 69,74,000 | 97,18,000 | ||||
9 | Salvage Value | 4,50,00,000 | ||||||
10 | Discounting Factor @ 19% (WACC) | 0.8403 | 0.7062 | 0.5934 | 0.5934 | |||
11 | PV of Inflow (8x10) | 38,01,680.67 | 49,24,793.45 | 57,66,814.88 | 2,67,03,711.64 | |||
12 | Less: Withholding Tax @ 12%(11x12) | 4,56,201.68 | 5,90,975.21 | 6,92,017.79 | 32,04,445.40 | |||
13 | Available for Remmitence is A$(11-12) | 33,45,478.99 | 43,33,818.23 | 50,74,797.10 | 2,34,99,266.24 | |||
14 | Eaxchange rate $/A$ | 0.52 | 0.54 | 0.56 | 0.56 | |||
15 | Value in $ Available for Remmitence | 64,33,613.45 | 80,25,589.32 | 90,62,137.67 | 4,19,62,975.43 |
A)
Year 1 | Year 2 | Year3 |
64,33,613.45 | 80,25,589.32 | 5,10,25,113.10 |
B (a)
Calculation of relevent Discount rate | ||||
Capital Struture (a) | Cost of capital (b) | (a)x(b) | ||
Debt | 40% | 10% | 4.00% | |
Equity | 60% | 25% | 15.00% | |
WACC | 19.00% |
B (b) NPV in A$
NPV PV of Cash inflow - Pv of cash outflow | |||||
Cash inflow | 4,11,97,000.64 | (Total of A$ Inflow) | |||
Cash Outflow | 5,30,00,000 | (Initial A$ Outflow) | |||
NPV | -1,18,02,999.36 |
NPV in US$
Cash inflow US$
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