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International Financial Management




                    Notes


                                     Case Study  Capital Budgeting

                                            EA is a leading Indian manufacturer of high quality sports goods and related
                                           equipment. The company is planning to increase its exports in the coming years.
                                     CAs a part of its strategy it is thinking of establishing a subsidiary in France that
                                     would manufacture and sell the goods locally. The management has asked the various
                                     departments of the company to supply all relevant information for a multinational capital
                                     budgeting analysis. The relevant information is given below.

                                     Investment
                                     The total initial investment to finance the plant and equipment is estimated at 20 million
                                     French Francs (FF) which will be invested by the parent. Working capital requirements,
                                     estimated at FF 10 million, will be borrowed by the subsidiary from a local financial
                                     institution at an interest rate of 8 per cent per annum. The principal will be paid at the end
                                     of the 5th year when the project is terminated while the interest payments are to be paid
                                     by the subsidiary annually.
                                     Depreciation
                                     The French government will allow the company to depreciate the plant and equipment
                                     using the straight-line method. The depreciation expense will be FF 4 million per year.
                                     Project Life: The life of the project is expected to be 5 years.
                                     Price and Sales: The forecasted price and sales schedules for the next five years are as given
                                     below:
                                         Year             Price Per Unit                Sales in France
                                           1                 FF  600                      50,000  units
                                           2                 FF  600                      50,000  units
                                           3                 FF  650                      80,000  units
                                           4                 FF  660                     1,00,000  units
                                           5                 FF  680                     1,20,000  units
                                     Costs: The variable costs are FF 200/- per unit in year 1 and year 2, and are expected to rise
                                     to FF 250 for years 3, 4 and 5. The fixed costs (other than depreciation) are expected to be
                                     FF 1.5 million per year.
                                     Exchange Rate
                                     The spot exchange rate of the French Franc is ` 6.60. The forecasted exchange rate for all
                                     future period is ` 6.80.
                                     Remittances
                                     All profits after tax realised by the affiliate are transferable to the parent at the end of each
                                     year. The French government plans to impose no restrictions on remittance of cash flows
                                     but will impose a 5 per cent withholding tax on funds remitted by the subsidiary to the
                                     parent as mentioned earlier.
                                     French government taxes on income earned by subsidiary: The Indian government will
                                     allow a tax credit on taxes paid in France so that earnings remitted by the parent will not
                                     be taxed by the French government.
                                                                                                         Contd...



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