A multinational company is planning to set up a subsidiary company in India (where hitherto it was exporting) in view of growing demand for its…

CA Final · Advanced Financial Management · MTP · May 2025
A multinational company is planning to set up a subsidiary company in India (where hitherto it was exporting) in view of growing demand for its product and competition from other MNCs. The initial project cost (consisting of Plant and Machinery including installation) is estimated to be US$ 500 million. The net working capital requirements are estimated at US$ 50 million. The company follows straight line method of depreciation. Presently, the company is exporting two million units every year at a unit price of US$ 80, its variable cost per unit being US$ 40. The Chief Financial Officer has estimated the following operating cost and other data in respect of proposed project: (i) Variable operating cost will be US $ 20 per unit of production; (ii) Additional cash fixed cost will be US $ 30 million p.a. and project's share of allocated fixed cost will be US $ 3 million p.a. based on principle of ability to share; (iii) Production capacity of the proposed project in India will be 5 million units; (iv) Expected useful life of the proposed plant is five years with no salvage value; (v) Existing working capital investment for production & sale of two million units through exports was US $ 15 million; (vi) Export of the product in the coming year will decrease to 1.5 million units in case the company does not open subsidiary company in India, in view of the presence of competing MNCs that are in the process of setting up their subsidiaries in India; (vii) Applicable Corporate Income Tax rate is 35%, and (viii) Required rate of return for such project is 12%. Assuming that there will be no variation in the exchange rate of two currencies and all profits will be repatriated, as there will be no withholding tax, estimate Net Present Value (NPV) of the proposed project in India. Present Value Interest Factors (PVIF) @ 12% for five years are as below: Year 1 2 3 4 5 PVIF 0.8929 0.7972 0.7118 0.6355 0.5674

Suggested Answer and Working Notes:

(a) Financial Analysis whether to set up the manufacturing units in India or not may be carried using NPV technique as follows: I. Incremental Cash Outflows $ Million Cost of Plant and Machinery 500.00 Working Capital 50.00 Release of existing Working Capital (15.00) 535.00 II. Incremental Cash Inflow after Tax (CFAT) (a) Generated by investment in India for 5 years $ Million Sales Revenue (5 Million x $80) 400.00 Less: Costs Variable Cost (5 Million x $20) 100.00 Fixed Cost 30.00 Depreciation ($500Million/5) 100.00 EBIT 170.00 Taxes @35% 59.50 EAT 110.50 Add: Depreciation 100.00 CFAT (1-5 years) 210.50 (b) Cash flow at the end of the 5 years (Release of Working Capital) 35.00 (c) Cash generation by exports (Opportunity Cost) $ Million Sales Revenue (1.5 Million x $80) 120.00 Less: Variable Cost (1.5 Million x $40) 60.00 Contribution before tax 60.00 Tax@35% 21.00 CFAT (1-5 years) 39.00 (d) Additional CFAT attributable to Foreign Investment $ Million Through setting up subsidiary in India 210.50 Through Exports in India 39.00 CFAT (1-5 years) 171.50 III. Determination of NPV Year CFAT ($ Million) PVF@12% PV ($ Million) 1-5 171.50 3.6048 618.2232 5 35 0.5674 19.8590 638.0822 Less: Initial Outflow 535.0000 103.0822 Since NPV is positive the proposal should be accepted.

Topics: International Financial Management

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