Question

Elvis Inc. is planning to establish a subsidiary in Australia to produce canola oil. The manufacturing facility will cost the parent company an initial investment of 5 million U.S. dollars (US$) to set up. The project will end in 3 years. At the end of the project, Elvis will sell the Australian subsidiary for A$8 million to an Australian agriculture firm. This amount is net of capital gain tax and is not subject to the withholding tax. Elvis estimates the after-tax net cash flows are A$6,400,000, A$3,000,000, and A$5,900,000 at the end of the first, second and third year, respectively. The Australian government will impose a corporate tax of 27% and a withholding tax of 19% on remitted funds. Additionally, the Australian law requires the subsidiary to operate locally at least for 3 years before it can remit earnings to its parent company. The parent's required rate of return for the Australian project is 10%. Suppose that the subsidiary can invest at 5% p.a. in Australia throughout the project duration and the exchange rate for the Australian dollar would remain unchanged at $0.141 throughout the project duration. Conduct a capital budgeting analysis to determine the feasibility of this project by completing the table below.

		Year 0	Year 1	Year 2	Year 3
1	Before-tax earnings of subsidiary (A$)
2	Host government tax (A$)
3	After-tax earnings of subsidiary (A$)
4	A$ Net cash flow to subsidiary
5	A$ remitted by subsidiary (100% of net cash flow)
	Reinvested fund from year 1
	Reinvested fund from year 2
5a	Accumulated A$
6	Withholding tax on remitted funds
7	A$ remitted after withholding tax
8	Salvage value
9	Exchange rate
10	Cash flows to parent
11	PV of parent cash flows
12	Initial investment (US$)
13	Cumulative NPV (US$)

Answer 1

		Year 0	Year 1	Year 2	Year 3
1	Before-tax earnings of subsidiary (A$)		87,67,123	41,09,589	80,82,192
2	Host government tax (A$)		0.27	0.27	0.27
3	After-tax earnings of subsidiary (A$)		64,00,000	30,00,000	59,00,000
4	A$ Net cash flow to subsidiary		64,00,000	30,00,000	59,00,000
5	A$ remitted by subsidiary (100% of net cash flow)
	Reinvested fund from year 1		64,00,000
	Reinvested fund from year 2			30,00,000
5a	Accumulated A$		64,00,000	94,00,000	1,53,00,000
6	Withholding tax on remitted funds				0.19
7	A$ remitted after withholding tax				29,07,000
8	Salvage value (US$)				11,28,000
9	Exchange rate	0.141	0.141	0.141	0.141
10	Cash flows to parent (US$)		9,02,400	4,23,000	8,31,900
11	PV of parent cash flows (US$)		8,59,428.57	3,83,673.47	16,93,035.31
12	Initial investment (US$)	50,00,000
13	Cumulative NPV (US$)		-41,40,571.43	-37,56,897.96	-20,63,862.65

Since Cumulative NPV is in negative at end of year 3, as per NPV the project should be rejected as it is not feasible.