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Natural Mosaic. Natural Mosaic Company (U.S.) is considering investing Rs50,000,000 in India to create a wholly...

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 31st of each succeeding year. Annual cash dividends to Natural Mosaic 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 on December 31st for the next six years as 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?

Please show calculations!

Solutions

Expert Solution

Calculation of Net present value

Year Cashflow DF @20% PV
0 2011 $ (1,000,000.00) 1.0000 $ (1,000,000.00)
1 2012 $          83,333.33 0.8333 $          69,444.44
2 2013 $          77,586.21 0.6944 $          53,879.31
3 2014 $          72,580.65 0.5787 $          42,002.69
4 2015 $          68,181.82 0.4823 $          32,880.89
5 2016 $    1,492,857.14 0.4019 $       599,945.80
Net Present Value $     (201,846.86)

Net present value of project is $(201,846.86)

Calculation of cash flow
Particular / Year 2011 2012 2013 2014 2015 2016
Investment INR (50,000,000) INR                     -   INR                     -   INR                     -   INR                     -   INR                       -  
Account income INR                      -   INR     6,000,000 INR     6,000,000 INR     6,000,000 INR     6,000,000 INR        6,000,000
Dividend - 75% 75% 75% 75% 75%
Dividend in INR INR                      -   INR     4,500,000 INR     4,500,000 INR     4,500,000 INR     4,500,000 INR        4,500,000
Subsidiary sold INR                      -   INR                     -   INR                     -   INR                     -   INR                     -   INR   100,000,000
Total INR (50,000,000) INR     4,500,000 INR     4,500,000 INR     4,500,000 INR     4,500,000 INR   104,500,000
Exchange Rate 50 54 58 62 66 70
Cashflow in $ $    (1,000,000.00) $          83,333.33 $          77,586.21 $          72,580.65 $          68,181.82 $       1,492,857.14

Calculation of IRR

We take two different discounting factor and interpolate it.

Year Cashflow DF @15% PV
0 2011 $ (1,000,000.00) 1.0000 $ (1,000,000.00)
1 2012 $          83,333.33 0.8696 $          72,463.77
2 2013 $          77,586.21 0.7561 $          58,666.32
3 2014 $          72,580.65 0.6575 $          47,722.95
4 2015 $          68,181.82 0.5718 $          38,983.18
5 2016 $    1,492,857.14 0.4972 $       742,213.84
Net Present Value $       (39,949.94)
Year Cashflow DF @13% PV
0 2011 $ (1,000,000.00) 1.0000 $ (1,000,000.00)
1 2012 $          83,333.33 0.8850 $          73,746.31
2 2013 $          77,586.21 0.7831 $          60,761.38
3 2014 $          72,580.65 0.6931 $          50,302.03
4 2015 $          68,181.82 0.6133 $          41,817.19
5 2016 $    1,492,857.14 0.5428 $       810,263.05
Net Present Value $          36,889.95

Interpolate = 13% + [$36,889.95 / {$36,889.95 - (-$39,949.94)} x 2%

= 13% + ($36,889.95 / $76,839.89) x 2%

= 13% + 0.9602%

= 13.96%

Internal rate of return 13.96%

(In case of any help require regarding this question please comment, I will help.)


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