Suppose you are analyzing the projected profitability of an international subsid
ID: 2803941 • Letter: S
Question
Suppose you are analyzing the projected profitability of an international subsidiary’s cash flows from the parent’s perspective that would result from a potential capital investment. How should you handle each of the following in calculating the cash flows that come to the parent? Be specific.
1) An increase of $300,000 per year in the transfer price of intermediate goods charged to the subsidiary that will result from the new investment.
2) The $2,000,000 decline in Brazilian revenues that will result from lost tax incentives in the Brazilian subsidiary if the firm shifts production out of Brazil and into its new Indonesian subsidiary
Explanation / Answer
1) $300,000 should be added to cashflow of the subsidiary as it is a incremental cashflow to the subsidiary due to the new investment it made in it
2) $2,000,000 decline in Brazilian revenue due to lost tax incentive is not a direct benefit/cost associated with Indonesian Subsidiary. It is kind of like a opportunity cost in this scenario. And it is not a incremental cashflow associated with investment in Indonesia. Therefore it cannot be substracted as cost from cashflow of Indonesian Subsidiary. It would just affect Brazilian revenue.