A Berhad, a Malaysian conglomerate, is considering setting up a subsidiary in Singapore to manufacture and sell in that country products currently made in Malaysia. An initial investment of S$5 million in plant and machinery would be needed. An initial investment in working capital S$500,000 would be financed by a loan from a local bank, at annual interest rate of 12 percent per year. At the end of five years, the subsidiary would be sold back to the Singaporean government as a going concern for S$12 million and part of the proceeds would be used to pay off the bank loan.

The subsidiary is expected to produce net cash flows from operations of S$3 million per year in current price terms over the five-year period before allowing for Singapore inflation of 7 percent. Capital allowance on the initial investment on plant and machinery are available on a straight-line basis at 20 percent per year. As a result of setting up the subsidiary in Singapore, A Berhad expects to lose after-tax income from Singapore of RM80,000 per year in current price terms, before allowing for Malaysian inflation of 4 percent per year.

Profits in Singapore are taxed at a rate of 22 percent after interest and capital allowance. All after-tax cash profits are remitted to Malaysia at the end of each year. Malaysian tax of 27 percent is charged on Malaysian profits but a tax treaty between Singapore and Malaysia allows tax paid in Singapore to be set off against any Malaysian liability. Taxation is paid in the year in which the liability arises.

A Berhad has a policy on foreign investments to be discounted at a money weighted average cost of capital of 15 percent. Real cost of capital is 6.5 percent. The current exchange rate is S$2.50/RM1.00 and the Singapore dollar is expected to depreciate against the Malaysian Ringgit by 5.5 percent per year.

Required:

Advise whether the proposed investment is financially acceptable to A Berhad. (to the nearest ‘000) 

Answer rating: 100% (QA)

Advice Proposed investment sho... View the full answer