Question: Suppose that Sherman Co., a U.S.-based MNC is considering a plan to establish a subsidiary in Singapore. The MNC would establish the subsidiary using an
Suppose that Sherman Co., a U.S.-based MNC is considering a plan to establish a subsidiary in Singapore. The MNC would establish the subsidiary using an upfront investment of $10,000,000 and would sell the subsidiary after four years. While it is confident in the values of certain parameters of the capital budgeting analysis, there is some substantial risk in the tax rate on earnings remitted from Singapore as well as the salvage value.
In particular, Sherman believes that there are two possible tax rates with the following probabilities.
| Possible Tax Rate Outcome | Probability of Outcome |
|---|---|
| 10.00% | 70.00% |
| 20.00% | 30.00% |
| 100% |
Additionally, Sherman believes that there are two possible salvage values with the following probabilities.
| Possible Salvage Value Outcome | Probability of Outcome |
|---|---|
| $12,000,000 | 60.00% |
| $7,000,000 | 40.00% |
| 100% |
Since there are two possible values for the tax rate, and two possible values for the salvage value, there are four total scenarios as outlined in the following table.
| Scenario | Withholding Tax | Salvage Value |
|---|---|---|
| 1 | 10.00% | S$12,000,000 |
| 2 | 20.00% | S$12,000,000 |
| 3 | 10.00% | S$7,000,000 |
| 4 | 20.00% | S$7,000,000 |
Given these scenarios, Sherman seeks to estimate the expected net present value of the project in the face of this uncertainty.
Consider scenario 2, where the tax rate on remitted earnings is 20.00% and the salvage value is S$12,000,000. A subsection of Shermans capital budgeting analysis is shown in the following table, beginning with the Singapore dollars generated by the subsidiary that will be remitted to Sherman.
Complete row (15) of the table, filling in the taxes paid (in Singapore dollars) on remitted funds in each year. Then complete row (16), filling in the total after-tax Singapore dollars remitted to the parent in each year. Next, complete row (19), filling in the U.S. dollar cash flows to the parent (after taxes).
| __________________________________________ | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 |
|---|---|---|---|---|---|
| 14. S$ Remitted before Taxes | $6,000,000 | $6,000,000 | $7,600,000 | $8,400,000 | |
| 15.Taxes (20.00%) | S
| S
| S
| S
| |
| 16. After-Tax S$ Remit | S
| S
| S
| S
| |
| 17. Salvage Value | $12,000,000 | ||||
| 18. Exchange Rate of S$ | $0.50 | $0.50 | $0.50 | $0.50 | |
| 19. After-Tax Cash Flows to Parent |
|
|
|
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