Question

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 31st 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 rate 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 31st 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?

Comment:

1. You have to do this problem from the viewpoint of the parent.

Thank you,

Answer 1

Yr	Cash flows	Rs/$	Dollar Income	Discounting factor @ 20%	Present Value
31-12-2011	-50000000	50	-1000000	1	-1000000
31-12-2012	2500000	54	46296.2963	0.833333	38580.25
31-12-2013	2500000	58	43103.44828	0.694444	29932.95
31-12-2014	2500000	62	40322.58065	0.578704	23334.83
31-12-2015	2500000	66	37878.78788	0.482253	18267.16
31-12-2016	102500000	70	1464285.714	0.401878	588463.6
			Net Present Value		-301421
Annual Cash dividends to Philadelphia Composite from India = 75% accounting income
Accounting Income = 6000000*75%			4500000
Cash flow available = 6000000-4500000+1000000			2500000
Discount Rate 14%+6%	20%
Assuming IRR is 10%
Yr	Cash flows	Rs/$	Dollar Income	Discounting factor @ 10%	Present Value
31-12-2011	-50000000	50	-1000000	1	-1000000
31-12-2012	2500000	54	46296.2963	0.909091	42087.54
31-12-2013	2500000	58	43103.44828	0.826446	35622.68
31-12-2014	2500000	62	40322.58065	0.751315	30294.95
31-12-2015	2500000	66	37878.78788	0.683013	25871.72
31-12-2016	102500000	70	1464285.714	0.620921	909206.2
			Net Present Value		43083.12
Assuming IRR is 11.0026254%
Yr	Cash flows	Rs/$	Dollar Income	Discounting factor @ 10.99%	Present Value
31-12-2011	-50000000	50	-1000000	1	-1000000
31-12-2012	2500000	54	46296.2963	0.90088	41707.39
31-12-2013	2500000	58	43103.44828	0.811584	34982.07
31-12-2014	2500000	62	40322.58065	0.73114	29481.43
31-12-2015	2500000	66	37878.78788	0.658669	24949.57
31-12-2016	102500000	70	1464285.714	0.593381	868879.5
			Net Present Value		0.00
The Net Present Value will be -$301421 and IRR would be approx 11.0026%