Question

InventBear Inc. is planning to establish a subsidiary in Australia to produce and sell gaming products locally. The project will end in three years and the subsidiary will be sold to an Australian firm for A$5 million at the end of the project. The salvage value is net of tax and will not be subject to withholding tax. InventBear estimates that, after paying for the income tax, the Australian subsidiary can remit A$5,450,000 to the parent every year for the next three years, starting at the end of the first year. The Australian subsidiary will require an initial investment of 7 million U.S. dollars (US$). The Australian government will impose a 25% withholding tax on the remitted funds. The subsidiary will remit all net cash flows to its parent at the end of each year. The company forecasts the exchange rate for the next three years using the current spot rate at US$0.91/A$. The parent’s required rate of return for the Australian subsidiary is 16%. If the U.S. government does not tax the A$ income, how much U.S. dollars will InventBear Inc. receive from the Australian subsidiary at the end of the third year?

a. US$4,268,859

b. US$3,719,625

c. US$8,269,625

d. US$8,715,980

Answer 1

We will calculate the amount with the help of following table:

Year	Particulars	Cashflow (AUD)	Exchange rate	Cashflow (USD)	Discount rate @16%	Discounted Cashflow (USD)
0	Initial Investment			(7,000,000)	1.0000	(7,000,000)
1	Cash remmited	4,087,500	0.91	3,719,625	0.8621	3,206,573
	(5,450,000*75%)
2	Cash remmited	4,087,500	0.91	3,719,625	0.7432	2,764,287
	(5,450,000*75%)
3	Cash remmited	4,087,500	0.91	3,719,625	0.6407	2,383,006
	(5,450,000*75%)
3	Sale value	5,000,000	0.91	4,550,000	0.6407	2,914,992
	Total					4,268,859

Thus we can conclude that the amount which the InventBear Inc. will take after three year is $4,268,859.

The answer for the given question is option (a).