FINA 6910 Week 9
FINA 6910 Week 9
Sheet1
Problem 18.4 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 below.
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 6 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.
What is the net present value and internal rate of return on this investment?
Assumptions Values Assumptions Values
Initial investment in India (Rs) 50,000,000 Dividend distribution per year 75.00%
Indian corporate tax rate 50.00% US corporate tax rate 40.00%
Sale price in year 5 (Rs) 100,000,000 India risk premium to WACC 6.00%
Natural Mosaic’s WACC 14.00%
Pro forma income and cash flow 0 1 2 3 4 5
(December 31st) 2011 2012 2013 2014 2015 2016
Sales revenue 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000
Less cash operating expenses (17,000,000) (17,000,000) (17,000,000) (17,000,000) (17,000,000)
Gross income 13,000,000 13,000,000 13,000,000 13,000,000 13,000,000
Less depreciation expenses (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000)
Earnings before interest and taxes 12,000,000 12,000,000 12,000,000 12,000,000 12,000,000
Less Indian taxes at 50% (6,000,000) (6,000,000) (6,000,000) (6,000,000) (6,000,000)
Net income 6,000,000 6,000,000 6,000,000 6,000,000 6,000,000
Add back depreciation
Annual cash flow
Initial investment (50,000,000)
Terminal value, sales 100,000,000
Cash flows for discounting
Present value factor 20% 1.0000 0.8333 0.6944 0.5787 0.4823 0.4019
Present value of cash flow
NPV of India investment (project view)
IRR of Indian investment (project view)
Cash inflows & outflows to US 2011 2012 2013 2014 2015 2016
Initial investment (Rs) (50,000,000)
Dividends received in the US (Rs)
Sales value (Rs)
Net cash flows to parent after-tax (Rs)
Expected exchange rate (Rs/$) 50.00 54.00 58.00 62.00 66.00 70.00
Net cash flows to parent after-tax (US$)
Present value factor 20% 1.0000 0.8333 0.6944 0.5787 0.4823 0.4019
Present value of cash flow
NPV of cash flows (parent viewpoint)
IRR of cash flows (parent viewpoint)
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