VIPSolutionsNMC (a U.S. firm) is considering investing Rs 50,000,000 in India to create a wholly owned tile manufacturing plant to export to the European market. After five years the subsidiary would be sold to Indian investors for Rs 100,000,000 . Sales revenue is projected to be Rs30,000,000 per year, operating expenses are projected to be Rs 17,000,000 per year, and depreciation expenses Rs1,000,000 per year. The initial investment will be made on December 31, 2011, and cash flows will occur on December 31st of each succeeding year. Annual cash dividends to NMC from India will equal 75% of accounting income. The U.S. corporate tax rate is 40% and the Indian corporate tax rate is 50% . Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to NMC will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. NMC uses a weighted average cost of capital of 14% on domestic investments, but will add 6 percentage points for the Indian investment because of perceived greater risk. NMC forecasts the rupee/dollar exchange rate for December 31 st on the next six years are listed below. Expected exchange rates (in Rs/$ ) for December 31st on the next six years (2011−2016) are 50.00,54.00,58.00,62.00,66.00 , and 70.00. What is the net present value and internal rate of return on this investment?
Question:
NMC (a U.S. firm) is considering investing Rs 50,000,000 in India to create a wholly owned tile manufacturing plant to export to the European market. After five years the subsidiary would be sold to Indian investors for Rs 100,000,000 . Sales revenue is projected to be Rs30,000,000 per year, operating expenses are projected to be Rs 17,000,000 per year, and depreciation expenses Rs1,000,000 per year. The initial investment will be made on December 31, 2011, and cash flows will occur on December 31st of each succeeding year. Annual cash dividends to NMC from India will equal 75% of accounting income. The U.S. corporate tax rate is 40% and the Indian corporate tax rate is 50% . Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to NMC will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. NMC uses a weighted average cost of capital of 14% on domestic investments, but will add 6 percentage points for the Indian investment because of perceived greater risk. NMC forecasts the rupee/dollar exchange rate for December 31 st on the next six years are listed below. Expected exchange rates (in Rs/$ ) for December 31st on the next six years (2011−2016) are 50.00,54.00,58.00,62.00,66.00 , and 70.00. What is the net present value and internal rate of return on this investment?
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Asked by: Asmita sharma
Created at: 2025-05-31 11:07:45
Asked by: Asmita sharma
Created at: 2025-05-31 11:07:45
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Let's break down the problem step by step to calculate **Net Present Value (NPV)** and **Internal Rate of Return (IRR)** **in USD** for NMC's investment in India.
### **Given Data**
- **Initial Investment:** Rs 50,000,000 (outflow at t=0, Dec 31, 2011)
- **Annual Sales Revenue:** Rs 30,000,000 (for 5 years)
- **Annual Operating Expenses:** Rs 17,000,000
- **Annual Depreciation:** Rs 1,000,000
- **Project Lifetime:** 5 years (2012-2016)
- **Terminal Value (sale in 2016):** Rs 100,000,000
- **Dividends remitted to US:** 75% of accounting income each year
- **Corporate Tax Rates:** US = 40%, India = 50% (no additional US tax due to higher Indian tax)
- **No capital gains tax on final sale**
- **WACC for this project:** 14% + 6% = **20%**
- **Exchange Rates (Rs/$):**
- 2011: 50.00 (for initial investment)
- 2012: 54.00
- 2013: 58.00
- 2014: 62.00
- 2015: 66.00
- 2016: 70.00
---
## **Step 1: Calculate Accounting Income**
Accounting Income = Sales - Operating Expenses - Depreciation
- Sales: Rs 30,000,000
- Operating Expenses: Rs 17,000,000
- Depreciation: Rs 1,000,000
**EBITDA:** 30,000,000 - 17,000,000 = **Rs 13,000,000**
**EBIT:** EBITDA - Depreciation = 13,000,000 - 1,000,000 = **Rs 12,000,000**
**Tax (50% Indian):** 0.5 × 12,000,000 = **Rs 6,000,000**
**Net Income:** 12,000,000 - 6,000,000 = **Rs 6,000,000**
---
## **Step 2: Calculate Dividends Remitted**
Dividend = 75% × Net Income = 0.75 × 6,000,000 = **Rs 4,500,000 per year**
---
## **Step 3: Calculate After-Tax Cash Flows**
### **A. Annual Operating Cash Flows**
- Net Income: Rs 6,000,000
- Add back Depreciation (non-cash): Rs 1,000,000
**Total Cash Flow before Dividend Remittance:**
6,000,000 + 1,000,000 = **Rs 7,000,000**
But **only 75% of net income is remitted as dividend**; remaining cash stays in India and will be repatriated upon sale.
#### **Annual Remitted Cash Flow to Parent (NMC):**
- Dividend: Rs 4,500,000 per year
#### **Retained Cash in India:**
- Cash Flow - Dividend = 7,000,000 - 4,500,000 = **Rs 2,500,000 per year** (accumulates in India for 5 years)
### **B. Terminal Cash Flow (at end of year 5, Dec 31, 2016)**
- Sale of subsidiary: Rs 100,000,000
- Add retained cash: 2,500,000 × 5 = **Rs 12,500,000**
- **Total terminal cash flow:** 100,000,000 + 12,500,000 = **Rs 112,500,000**
---
## **Step 4: Convert Rupee Cash Flows to USD**
| Year | Rs Outflow/Inflow | Exchange Rate | USD Amount |
|------|-------------------|--------------|-----------------------|
| 0 | -50,000,000 | 50.00 | -1,000,000 |
| 1 | 4,500,000 | 54.00 | 83,333 |
| 2 | 4,500,000 | 58.00 | 77,586 |
| 3 | 4,500,000 | 62.00 | 72,581 |
| 4 | 4,500,000 | 66.00 | 68,182 |
| 5 | 4,500,000 | 70.00 | 64,286 |
| 5 | 112,500,000 | 70.00 | 1,607,143 |
**Note:** Year 5 gets both the last annual dividend (4,500,000) and the terminal cash flow (112,500,000).
---
## **Step 5: Create Cash Flow Timeline (in USD)**
| Year | Cash Flow (USD) |
|------|-----------------|
| 0 | -1,000,000 |
| 1 | 83,333 |
| 2 | 77,586 |
| 3 | 72,581 |
| 4 | 68,182 |
| 5 | 64,286 + 1,607,143 = **1,671,429** |
---
## **Step 6: Calculate NPV at 20% Discount Rate**
NPV = -1,000,000 + Σ [CFt / (1 + 0.20)^t]
Let's calculate each term:
- **Year 1:** 83,333 / 1.20 = 69,444
- **Year 2:** 77,586 / (1.20^2) = 77,586 / 1.44 = 53,883
- **Year 3:** 72,581 / (1.20^3) = 72,581 / 1.728 = 42,010
- **Year 4:** 68,182 / (1.20^4) = 68,182 / 2.0746 = 32,874
- **Year 5:** 1,671,429 / (1.20^5) = 1,671,429 / 2.48832 = 671,837
**Sum of discounted cash flows (years 1-5):**
69,444 + 53,883 + 42,010 + 32,874 + 671,837 = **869,048**
**NPV = -1,000,000 + 869,048 = -$130,952**
---
## **Step 7: Calculate IRR**
IRR is the rate 'r' that sets NPV = 0:
0 = -1,000,000 + Σ [CFt / (1 + r)^t]
Let's estimate using the cash flows:
| Year | USD Cash Flow |
|------|---------------|
| 0 | -1,000,000 |
| 1 | 83,333 |
| 2 | 77,586 |
| 3 | 72,581 |
| 4 | 68,182 |
| 5 | 1,671,429 |
We'll try rates:
- At 20%: NPV = -130,952 (from above)
- At 14% (lower required return):
Year 1: 83,333 / 1.14 = 73,090
Year 2: 77,586 / (1.14^2) = 59,743
Year 3: 72,581 / (1.14^3) = 48,016
Year 4: 68,182 / (1.14^4) = 38,826
Year 5: 1,671,429 / (1.14^5) = 866,387
Sum: 73,090 + 59,743 + 48,016 + 38,826 + 866,387 = 1,085,062
NPV = -1,000,000 + 1,085,062 = **$85,062**
So, IRR is between 14% and 20%.
Now, try **16%**:
Year 1: 83,333 / 1.16 = 71,849
Year 2: 77,586 / (1.16^2) = 57,646
Year 3: 72,581 / (1.16^3) = 45,967
Year 4: 68,182 / (1.16^4) = 36,947
Year 5: 1,671,429 / (1.16^5) = 781,432
Sum: 71,849 + 57,646 + 45,967 + 36,947 + 781,432 = 993,841
NPV = -1,000,000 + 993,841 = **-6,159**
Now try **15.5%**:
Year 1: 83,333 / 1.155 = 72,170
Year 2: 77,586 / (1.155^2) = 58,286
Year 3: 72,581 / (1.155^3) = 47,004
Year 4: 68,182 / (1.155^4) = 38,012
Year 5: 1,671,429 / (1.155^5) = 814,094
Sum: 72,170 + 58,286 + 47,004 + 38,012 + 814,094 = 1,029,566
NPV = -1,000,000 + 1,029,566 = **29,566**
So, 15.5% gives a positive NPV, 16% gives negative NPV. Let's interpolate:
IRR ≈ 15.5% + [29,566 / (29,566 + 6,159)] × (16% - 15.5%)
= 15.5% + [29,566 / 35,725] × 0.5%
= 15.5% + 0.414 × 0.5% ≈ 15.5% + 0.21% ≈ **15.7%**
---
## **Summary Table**
| Metric | Value |
|----------------|----------|
| **NPV (at 20%)** | **-$130,952** |
| **IRR** | **~15.7%** |
---
### **Conclusion**
- **NPV (at required rate of 20%) = -$130,952** (Investment is not justified at this hurdle rate)
- **IRR = 15.7%** (Below required rate of return of 20%, but above a typical US domestic WACC)
**Thus, based on a 20% required rate of return, this investment should be rejected by NMC.**
---
### **If you need the NPV in INR or with alternate assumptions, let me know!**
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