18.4 Natural Mosaic.
Natural Mosaic Company (U.S.) is considering investing INR50,000,000 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 INR100,000,000. A pro forma income statement for the Indian operation predicts the generation of INR7,000,000 of annual cash flow, is listed in the following table.
Sales revenue 30,000,000
Less cash operation expenses (17,000,000)
Gross income 13,000,000
Less depreciation expenses (1,000,000)
Earnings before interest and taxes 12,000,000
Less Indian taxes at 50% (6,000,000)
Net income 6,000,000
Add back depreciation 1,000,000
Annual cash flow 7,000,000
The initial investment will be made on December 31, 2021, and cash flows will occur on December 31 of each succeeding year. Annual cash dividends to Natural Mosaic from India will equal 75% of accounting income. The U.S. corporate tax rate is 21% and the Indian corporate tax rate is 25%. Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to Natural Mosaic will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. Natural Mosaic uses a weighted average cost of capital of 14% on domestic investments but will add six percentage points for the Indian investment because of perceived greater risk. Natural Mosaic forecasts the rupee/dollar exchange rate for December 31st on the next six years are listed below.
R$/$ R$/$
2021 76 2024 88
2022 80 2025 92
2023 84 2026 96
What is the net present value and internal rate of return on this investment?
ESSAY (WRITE AN ESSAY BASED ON YOUR SOLUTION: )
*2. In problem one, the assumption is the $ revalued against the rupee as indicated in the problem, and that the euro and the $ move together, in lockstep, in terms of the ER. Presuppose additionally, we know the euro and the $ revalue against the rupee by what is indicated in problem one, and the $ and euro continue to appreciate against the rupee for the next 20 years. Before we presupposed the sales to Europe do not alter due to the rupee depreciation. However, now we make a huge change in the assumptions. How would the results of problem one alter, if we assume that sales from India to Europe rise inter temporally for 20 years. Furthermore, presuppose the price elasticity of demand is – 4 for the product in Europe (how European customers see it.) Elaborate on the possible altered effect of the NPV of the Indian investment.
