A proposed foreign investment involves creation of a plant with an annual output of 1 million units. The entire production will be exported at a…

CA Final · Advanced Financial Management · RTP · May 2025
A proposed foreign investment involves creation of a plant with an annual output of 1 million units. The entire production will be exported at a selling price of USD 10 per unit. At the current rate of exchange dollar cost of local production equals to USD 6 per unit. Dollar is expected to decline by 10% or 15%. The change in local cost of production and probability from the expected current level will be as follows: Decline in value of USD (%) Reduction in local cost of production (USD/ unit) Probability 0 - 0.40 10 0.30 0.40 15 0.15 Additional Reduction 0.20 The plant at the current rate of exchange will have a depreciation of USD 1 million annually. Assume local Tax rate as 30%. You are required to find out: (i) Annual Cash Flow After Tax (CFAT) under all the different scenarios of exchange rate. (ii) Expected value of CFAT assuming no repatriation of profits. (iii) Viability of the investment proposal assuming an initial investment of USD 25 million on plant and working capital with a required rate of return of 11% on investment and on the basis of CFAT arrived under option (ii). The CFAT will grow @ 3% per annum in perpetuity.

Suggested Answer and Working Notes:

(i) Calculation of Annual CFAT Scenario 1 Scenario 2 Scenario 3 Annual Sales (in units) (A) 10,00,000 10,00,000 10,00,000 US $ US $ US $ Selling price p.u. 10.00 10.00 10.00 Cost p.u. 6.00 5.70 5.55 Profit p.u. (B) 4.00 4.30 4.45 Total Profit (A x B) 40,00,000 43,00,000 44,50,000 Less: Depreciation 10,00,000 9,00,000 8,50,000 PBT 30,00,000 34,00,000 36,00,000 Less: Tax @30% 9,00,000 10,20,000 10,80,000 PAT 21,00,000 23,80,000 25,20,000 Add: Depreciation 10,00,000 9,00,000 8,50,000 Expected CFAT (US$) 31,00,000 32,80,000 33,70,000 (ii) Expected value of CFAT = US$ 31,00,000 x 0.4 + US$ 32,80,000 x 0.4 + US$ 33,70,000 x 0.2 = US$ 32,26,000 (iii) Viability of Proposal: Expected CFAT = US $ 32,26,000 Expected Growth Rate = 3% Expected Value of inflow in perpetuity = US$32,26,000(1.03) / (0.11-0.03) = 33,22,780 / 0.08 = US$ 4,15,34,750 US $ Value of Inflows 4,15,34,750 Less: Initial Outlay 2,50,00,000 NPV of project 1,65,34,750 Since NPV is positive, project is viable.

Topics: International Financial Management

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