Strategic Finance ML Corporation (a US based MNC) presently has no existing busi
ID: 1171971 • Letter: S
Question
Strategic Finance ML Corporation (a US based MNC) presently has no existing business in Germany but is considered the establishment of a subsidiary. The following information is given to assess this project: The initial investment of fixed assets in year zero is Euro 60 million. The existing spot rate is $1.44 per Euro. Initial working capital is expected to be 15% of first year’s sales. Working capital is expected to remain same. The project will be terminated at the end of year 3, when the subsidiary will be sold. Working capital will be recovered (cash inflow) in the last year to the project The Price Demand and variable cost of the product in Germany are as follows: Year Price Demand Variable Cost 1 Euro 650 40,000 Units Euro 165 2 Euro 690 50,000 Units Euro 172 3 Euro 740 60,000 Units Euro 176 The fixed costs are estimated to be Euro 6 million per year. The exchange rate of Euro is expected to be $1.46 at the end of year 1, $1.47 at the end of year 2 and $1.48 at the end of year 3. The German government will impose a withholding tax of 15% on earning remitted by the subsidiary. The US will not impose any additional taxes. All cash flows generated by the subsidiary are transferred to the parent at the end od each year. The Fixed assets are depreciated over 10 years, using the straight-line method. The asset will have a value equal to its book value at the end of 3 years. The corporate tax rate is 32%. In the three years the subsidiary is to be sold. The project discount rate is expected to be 10% Assume tax rate is same in US as Germany. a. Should ML accept the project? Compute NPV from parent company point of view. b. What are the additional issues generally to be included in a foreign project appraisal compared to a domestic project appraisal?
Explanation / Answer
Since the NPV is positive thus project is acceptable
Issues in foreign project appraisal compared to a domestic project appraisal
1.Foreign currency fluctuations
2.Unknownness of the market behaviour
3.Remitance restriction
4. Tax Issues
5. Uncertain Salvage value
Evaluating the project for ML Corporation in Germany(In Euro) Year Investment in FA Initial Working Capital Margin (W.no.2) Fixed Cost (Margin-Fixed Cost)*(1-.32)=A Tax Saving on Dep.(W.no.1)=B 15% withholding tax on remmision(A+B)*15% Fixed Asset sold (W.no.3) Initial Working Cap. Net Cash Flow Exchage Rate Cash flow in US $ PVF @10% PV 0 -60000000 -3900000 -63900000 1.44 -92016000 1 -92016000 1 19400000 6000000 9112000 1920000 -1654800 9377200 1.46 13690712 0.909 12444857.21 2 25850000 6000000 13498000 1920000 -2312700 13105300 1.47 19264791 0.826 15912717.37 3 33840000 6000000 18931200 1920000 -3127680 42000000 3900000 63623520 1.48 94162810 0.751 70716270.01 Total 7057844.584