In: Finance
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!
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.)