SETTING UP THE SUBSIDIARY ABROAD:

PROBLEM NO$.1$

Endalco Ltd$.($EL$)$ of India is planning to set up a subsidiary in the USA $($where

hitherto it was exporting$)$ in view of the growing demand for its product and the

competition from other MNCs$.$

The initial project cost $($consisting of plant and machinery including installation$)$ is

estimated to be US dollar $400$ million; working capital requirements are estimated

at US dollar $40$ million.

The Indian company follows the straight line method of depreciation.

The General Manager $($Finance$)$ of EL estimated data in respect of the project as

follows:

i$)$ Variable cost of production and sales: $$25$ per unit

ii$)$ Fixed cost per annum are estimated at $$30$ million

iii$)$ The plant will be producing and selling $5$ million units at $$100$ per unit.

iv$)$ The expected economic useful life of the plant is $5$ years with no salvage

value.

The subsidiary of the Indian company is subject to $40\%$ corporate tax rate in the USA

and the required return of such a project is $12\%.$ The current exchange rate between

the two countries is Rs$\mathrm{.}48/$ US dollar and the rupee is expected to depreciate by $2\%$

p$.$a$.$ for the next $5$ years.

The subsidiary will be allowed to repatriate $70\%$ of the CFAT every year along with

the accumulated arrears of blocked funds at the year$-$end $5.$ The withholding taxes

are $10\%.$ The blocked funds will be invested in the USA money market by the

subsidiary, earning $4\%($free of tax$)$ per year.

Advise EL regarding financial viability of having a subsidiary company in the USA,

assuming no tax liability in India on earnings received by EL from the US subsidiary.

Note: Extract for from the table:

i$)$ Future value in year $5$ of Re$.1$ each during $1$ to $4$ years invested at $4\%$ per

year $=4\mathrm{.}246$

ii$)$ The present value factor at $12\%$ discount rate are: