Page 229 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT
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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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