An Indian company is planning to set up a subsidiary in US. The initial project cost is estimated to be US $40 million; Working Capital required is estimated to be $4 million.
The finance manager of company estimated the data as follows:
Variable Cost of Production (Per Unit Sold) $2.50
Fixed cost per annum $ 3 Million
Selling Price $ 10
Production capacity 5 million units
Expected life of Plant 5 years
Method of Depreciation Straight Line Method (SLM)
Salvage Value at the end of 5 years NIL
The subsidiary of the Indian company is subject to 40% corporate tax rate in the US and the required rate of return of such types of project is 12%. The current exchange rate is Rs.48/US$ and the rupee is expected to depreciate by 3% per annum for next five years.
The subsidiary company shall be allowed to repatriate 70% of the CFAT every year along with the accumulated arrears of blocked funds at the end of 5 years, the withholding taxes are 10%. The blocked fund will be invested in the USA money market by the subsidiary, earning 4% (free of taxes) per year.
Determine the feasibility of having a subsidiary company in the USA, assuming no tax liability in India on earnings received by the parent company from the US subsidiary.
Solution
Working Notes:
PV AF (4%, 4) 4.246
Value of Funds at end 30.4438 M$
Withholding Tax 3.0444 M$ 27.3994 M$
Decision : Since NPV of the project is positive, the Indian Company should go for its decision of subsidiary in US.
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