Required: Use an Excel spreadsheet to calculate the net present value NPV from a "Parent company perspective" (the PPC) The Malaysian subsidiary of the PPC distributed and assembled electric motors. It also had limited manufacturing facilities so that it could undertake particular adaptations required. With the maturing of the Asian market, particularly in the industrial sector, an expansion of capacity in that market was of strategic importance. The Malaysian subsidiary had been urging corporate management to expand its capacity since the beginning of 2015. However, an alternative scenario appeared more promising. The Indian economy, with its liberalized economic policies, was growing at annual rates much higher than those of many industrialized countries. Further, India had lower labor costs and specific government incentives that were not available in Malaysia. Therefore, the company chose India for its Asian expansion project and had a four-year investment project proposal prepared by the treasurer’s staff. The proposal was to establish a wholly owned subsidiary in India that would produce electric motors for the Indian domestic market as well as for export to other Asian countries. The initial equity investment would be $1.125 million, equivalent to 67.5 million Indian rupees (Rs) at the exchange rate of Rs 60 to the U.S. dollar. (Assume that the Indian rupee is freely convertible, and there are no restrictions on transfers of foreign exchange out of India.) An additional Rs 30 million would be raised by borrowing from a commercial bank in India at an interest rate of 10 percent per annum. The principal amount of the bank loan would be payable in full at the end of the fourth year. The combined capital would be sufficient to purchase the plant of $2 million and would cover other initial expenditures including working capital. The cost of installation would be $15,000 with another $5,000 for testing. No additional working capital would be required during the four years. The plant was expected to have a salvage value of Rs 10 million at the end of four years. Straight-line depreciation would be applied to the original cost of the plant. The firm’s overall marginal after-tax cost of capital was about 12 percent. However, because of the higher risks associated with an Indian venture, PPC decided that a 16 percent discount rate would be applied to the project. Present value factors at 16 percent are as follows: Period Factor 1 ……………………………... 0.862 2 ……………………………… 0.743 3 ……………………………… 0.641 4 ……………………………… 0.552 Sales forecasts are as follows: Sales (units) Year (Domestic) (Export) 1 …………………. 5,000 10,000 2 …………………. 6,000 12,000 3 …………………. 7,000 14,000 4 …………………. 8,000 16,000 The initial selling price of an electric motor was to be Rs 4,500 for Indian domestic sales and export sales in the Asian region, and the selling price in both cases was to increase at an annual rate of 10 percent. The exchange rate between the Indian rupee and the U.S. dollar was expected to vary as follows: January 1, Year 1 ………………. Rs 60 per U.S. dollar December 31, Year 1 ………………. Rs 60 per U.S. dollar December 31, Year 2 ………………. Rs 55 per U.S. dollar December 31, Year 3 ………………. Rs 50 per U.S. dollar December 31, Year 4 ………………. Rs 45 per U.S. dollar The cash expenditure for operating expenses, excluding interest payments, would be Rs 44 million in Year 1 and was expected to increase at a rate of 8 percent per year. The Indian subsidiary is expected to pay a royalty of Rs 20 million to the parent company at the end of each of the four years. Besides, in those years in which the subsidiary generates a profit, it will pay a dividend to PPC equal to 100 percent of net earnings. Through negotiation with the Indian government, the subsidiary will be exempt from Indian corporate income taxes and withholding taxes on payments made to the parent company. Royalties and dividends received from the Indian subsidiary are fully taxable in the United States at the U.S. corporate tax rate of 35 percent. PPC expects to be able to sell the Indian subsidiary at the end of the fourth year for its salvage value. PPC also expects to be able to repatriate to the parent the cash balance at the end of Year 4. The cash balance will be equal to the difference between the aggregate amount of cash flow from operations generated by the subsidiary over the four years (including plant salvage value and loan payment to a local bank) and the total amount of dividends paid to PPC. The repatriated cash balance will be taxed in the U.S. at 35 percent only if there is again after deducting the cost of the initial equity investment.
Required:
Use an Excel spreadsheet to calculate the
The Malaysian subsidiary of the PPC distributed and assembled electric motors. It also had limited manufacturing facilities so that it could undertake particular adaptations required. With the maturing of the Asian market, particularly in the industrial sector, an expansion of capacity in that market was of strategic importance. The Malaysian subsidiary had been urging corporate management to expand its capacity since the beginning of 2015. However, an alternative scenario appeared more promising. The Indian economy, with its liberalized economic policies, was growing at annual rates much higher than those of many industrialized countries. Further, India had lower labor costs and specific government incentives that were not available in Malaysia. Therefore, the company chose India for its Asian expansion project and had a four-year investment project proposal prepared by the treasurer’s staff.
The proposal was to establish a wholly owned subsidiary in India that would produce electric motors for the Indian domestic market as well as for export to other Asian countries. The initial equity investment would be $1.125 million, equivalent to 67.5 million Indian rupees (Rs) at the exchange rate of Rs 60 to the U.S. dollar. (Assume that the Indian rupee is freely convertible, and there are no restrictions on transfers of foreign exchange out of India.) An additional Rs 30 million would be raised by borrowing from a commercial bank in India at an interest rate of 10 percent per annum. The principal amount of the bank loan would be payable in full at the end of the fourth year. The combined capital would be sufficient to purchase the plant of $2 million and would cover other initial expenditures including working capital. The cost of installation would be $15,000 with another $5,000 for testing. No additional working capital would be required during the four years. The plant was expected to have a salvage value of Rs 10 million at the end of four years. Straight-line
The firm’s overall marginal after-tax cost of capital was about 12 percent. However, because of the higher risks associated with an Indian venture, PPC decided that a 16 percent discount rate would be applied to the project. Present value factors at 16 percent are as follows:
|
Period |
Factor |
|
|
1 |
……………………………... |
0.862 |
|
2 |
……………………………… |
0.743 |
|
3 |
……………………………… |
0.641 |
|
4 |
……………………………… |
0.552 |
Sales
|
Sales (units) |
|||
|
Year |
(Domestic) |
(Export) |
|
|
1 |
…………………. |
5,000 |
10,000 |
|
2 |
…………………. |
6,000 |
12,000 |
|
3 |
…………………. |
7,000 |
14,000 |
|
4 |
…………………. |
8,000 |
16,000 |
The initial selling price of an electric motor was to be Rs 4,500 for Indian domestic sales and export sales in the Asian region, and the selling price in both cases was to increase at an annual rate of 10 percent. The exchange rate between the Indian rupee and the U.S. dollar was expected to vary as follows:
|
January 1, Year 1 |
………………. |
Rs 60 per U.S. dollar |
|
December 31, Year 1 |
………………. |
Rs 60 per U.S. dollar |
|
December 31, Year 2 |
………………. |
Rs 55 per U.S. dollar |
|
December 31, Year 3 |
………………. |
Rs 50 per U.S. dollar |
|
December 31, Year 4 |
………………. |
Rs 45 per U.S. dollar |
The cash expenditure for operating expenses, excluding interest payments, would be Rs 44 million in Year 1 and was expected to increase at a rate of 8 percent per year. The Indian subsidiary is expected to pay a royalty of Rs 20 million to the parent company at the end of each of the four years. Besides, in those years in which the subsidiary generates a profit, it will pay a dividend to PPC equal to 100 percent of net earnings. Through negotiation with the Indian government, the subsidiary will be exempt from Indian corporate income taxes and withholding taxes on payments made to the parent company. Royalties and dividends received from the Indian subsidiary are fully taxable in the United States at the U.S. corporate tax rate of 35 percent.
PPC expects to be able to sell the Indian subsidiary at the end of the fourth year for its salvage value. PPC also expects to be able to repatriate to the parent the cash balance at the end of Year 4. The cash balance will be equal to the difference between the aggregate amount of cash flow from operations generated by the subsidiary over the four years (including plant salvage value and loan payment to a local bank) and the total amount of dividends paid to PPC. The repatriated cash balance will be taxed in the U.S. at 35 percent only if there is again after deducting the cost of the initial equity investment.
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