4) NMC (a U.S. firm) is considering investing Rs50,000,000 in India to create a

Question

4) NMC (a U.S. firm) is considering investing Rs50,000,000 in India to create a wholly owned tile manufacturing plant to export to the European market. After five years the subsidiary would be sold to Indian investors for Rs100,000,000. Sales revenue is projected to be Rs30,000,000 per year, operating expenses are projected to be Rs17,000,000 per year, and depreciation expenses Rs1,000,000 per year. The initial investment will be made on December 31,2011, and cash flows will occur on December 31st of each succeeding year. Annual cash dividends to NMC from India will equal 75% of accounting income. The U.S. corporate tax rate is 40% and the Indian corporate tax rate is 50%. Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to NMC will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. NMC uses a weighted average cost of capital of 14% on domestic investments, but will add 6 percentage points for the Indian investment because of perceived greater risk. NMC forecasts the rupee/dollar exchange rate for December 31st on the next six years are listed below.Expected exchange rates (in Rs/S) for December 31st on the next six years (2011 - 2016) are 50.00, 54.00, 58.00, 62.00, 66.00, and 70.00. What is the net present value and internal rate of return on this investment?

Explanation / Answer

IRR:

At around 13.935% NPV near 0, hence IRR= 13.935%

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Initial investment         (5,00,00,000) Dividends          45,00,000          45,00,000          45,00,000          45,00,000              45,00,000 Sale of investment        10,00,00,000 Net cash flow(INR)         (5,00,00,000)          45,00,000          45,00,000          45,00,000          45,00,000        10,45,00,000 Exchange rate                              50                        54                        58                        62                        66                            70 Net cash flow(USD)             (10,00,000)          83,333.33          77,586.21          72,580.65          68,181.82        14,92,857.14 Discount rate@ 20%                                1                0.8333                0.6944                0.5787                0.4823                    0.4019 Discounted cash flow             (10,00,000)          69,444.44          53,879.31          42,002.69          32,880.89          5,99,945.80 NPV         (2,01,846.86)

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