International Financial Management 1219993582593066 8

8/3/2019 International Financial Management 1219993582593066 8

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International Financial

Management

By Prof.Augustin Amaladas


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Objective

Explain international FM multinational

capital budgeting

Working capital

Sources of international finance

Special aspects related to the financial

decisions of MNCs and International firms


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Chapter-1

Multinational Capital budgeting


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Nature, difficulties and

importance MNCs face exchange rate risks,

Expropriation risk

Blocked funds

Foreign tax regulations

Political risk Basic business risks of foreign and domestic

projects


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Motivating factors

Comparative cost advantage

Taxation

Financial diversification to reduce risk


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Uniform basis of evaluation

Incremental cash outflows

Incremental cash inflows

Discounting at an appropriate cost of capital

NPV


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Incremental cash outflows

Cost of the proposed plant and equipment

+Shipping charges, custom duties, local transport

etc +Installation cost of plant and equipment

+Additional working capital

+Cost of technology transfer

+Training cost of personnel

- SALE PROCEEDS AFTER TAXES FROMEXISTING PLANT AND EQUIPMENT ANDTECHNOLOGY


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Incremental cash Inflows-

Cannibalisation Identify cash inflows exclusively/wholly

identifiable with the proposed project.

1.Cannibalisation:lost sales on existingproduct which was exported earlier

-loss of profit on lost sales to be

considered as outflow. Or reduction frominflow.


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2.Sales creation

Additional sales of existing products of

parent company

If newly set up all sales and profits arerelevant cash inflow


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3. Opportunity cost

Rent forgone on account of the proposed

project-cash inflow

Current market value of land and buildingthat are used for undertaking of a new

project-cost of the project.


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Treatment of fixed overheads

Additional fixed overheads are to be

considered

Existing overheads to be excluded


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Fees and royalties

Fees and royalties, management costs,

training of personnel by head office are to

be incurred unless they are additional.


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Intangible benefits

It is qualitative in nature

Better quality

Faster time to market

Higher customer satisfaction

Valuable learning experience Helpful to new and existing products


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Incremental Analysis

It is also known as additional benefit and

additional cost analysis.

Example-1:Costs that will be incurred infuture( less) savings on cost due to the new

project


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Relevant cost and relevant benefit

Allocated common costs are irrelevant

Opportunity costs are relevant (shadow

price) Incremental costs and incremental benefits

are relevant.

Avoidable costs are relevant andunavoidable costs are irrelevant for decisionmaking.


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Relevant and irrelevant

Five engineers already employed on monthly

salary but will not be sent out if not employed in

an another project. The salary paid to thoseengineers are relevant or irrelevant to estimate the

price for a new project which will be completed

with in a month?

Two more engineers are selected exclusive to thenew project.-Are the costs relevant to take

decision for new project?


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Example for relevant cost

Survey conducted by incurring Rs.10,00,000.

Product P can be produced and marketed. If P is

produced it estimated that 1,00,000 units perannum can be produced at a selling price of

Rs.100per unit.It requires a machine costs Rs.1.5

crores .The material, manufacturing variable

cost=Rs.65. What are relevant cost to take decision to go for

the project or not?


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Example-1

1. Machine just purchased a few days back by spending Rs. 20,00,000.Cost of running this machine per hour is 100. It is about to be installedbut we come across

an another efficient machine available in the market for Rs. 35,00,000.

Cost of running this machine=70 per hour. If new machine ispurchased the machine just bought can be disposed of for Rs12,00,000

Question 1. What are relevant costs in this problem?

2. If so, how many hours should we run minimum so that it is beneficial tothe company.

3. If company wants to run maximum 60000 hours which machine isbeneficial?

4. What is the Break even hours between these two machines?


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Example-2

We have manufactured 20,000 units of shirts which are

meant for export by spending Rs. 150 per shirt. We can

sell this product in the market for Rs. 120 per shirt because

of defects. We can further process them to rectify themistake by spending Rs.30.and we can export and sell for

Rs.160. Other good units are sold for Rs.200 per shirt.

Question: 1) What are relevent cost and relevant benefits?

Should we rectify them or not?

How much gain or loss if not rectified?.

How much gain or loss if rectified?.


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Example-3

X Ltd has a machine 001 produces product H. The

selling price of H is Rs.100 and marginal cost is

60.It takes 20 hours to produce one H. The company has alternative to produce product

S which takes 3 hours per unit of S.The marginal

cost of S=5. S can be purchased from market at a

price of Rs.10 Question: Should product S to be produced on the

same machine 001


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Exercise-4

An US multinational is planning to set up a subsidiary in Indiain view ofcost cutting measures.The initial project cost is $400 million. Working capitalrequired for the project is $.50 million. The company follows WDV method ofdepreciation.

At present it is exporting 2 million units every year at a unit price of US $80,its variable cost is $50.

As per the future plan it is estimated that variable cost is reduced by $30.Additional fixed cost per annum is $30 million and the share of allocated fixedcosts are to be $3 million. The capacity to produce in India is 4.0 million units.Useful life is 5 years and no salvage value.

The firms existing working capital investment in production and sales of 2million units was $10 million.

The export will decrease to 1.6 million units incase the firm does not set up theunit in India. The tax rate is 34% in India.The required rate of return is15%.The annual appreciation in rupee is 2%.The spot rate is 42/$.The profitscan be repartiated without withholding taxes, advise the US multinational

regarding the financial viability of having subsidiary in India.


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Answer

1.Incremental cash outflows:

Cost of plant and Machinery $400

Additional working capital

($50 million-release of existing working

capital $10 million) $40

Total Incremental cash outflow is $440


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2.Incremental cash Inflows:

Sales revenue(4 million x $80) $320

Less: Variable cost(4 million x$30) $ 120 Additional fixed cost $ 30

Depreciation per year($400 mill./5) $ 80

Earning before tax $90

Less: tax (34% x $90) $ 30.6

Profit after tax $59.4

Add:Depreciation $ 80

Cash Inflow per year $139.4 Cash inflow for release of working capital at the

end of the project (5th Year) $40


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3. Profit on lost sales:

Sales revenue( 1.6 mill.units x $80) $128mill. Less: variable cost(1.6mill.x $40) $ 64 mill.

Contribution(Sales-VC) $ 64 mill.

Less: taxes(34%) $ 21.76Mill. Contribution after taxes $42.24 Mill.

(Lost contribution per year)

4.Net cash inflow per year

$139.4-$42.24=$97.16 mill.


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Determination of NPV:

Particulars Cashflows

PVfactor

(15%)

Presentvalie

Year1

2

3

4

5

5 working capital

release

97.16

97.16

97.16

97.16

97.16

40.00

0.869

0.756

0.657

0.571

0.497

0.497

84.432

73.452

63.834

55.478

48.288

19.887

345.372


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NPV

Present value of incremental cash outflows$440

Present value of incremental cash inflow$345.37

Net present value(NPV) (94.62Mill)

Conclusion :Reject the project as NPV is negative as itis not financially viable.


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Cash flow at Independent

subsidiary as per Shapiro Sales revenue

Less: Variable costs

Less: Additional fixed costs

Less: Management fees charged by parent Less: Royalty for patents, licenses, brands charged by parent

Less: Depreciation/amortisation/non-cash expenses

Earnings before tax

Less: Earnings after taxes

Add:depreciation/amortisation/non-cash expenses CFAT(operating)

Add: salvage value of plant in the last year/one year after the lat year

Add: recovery of working capital(nth year or in earlier years)


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Cash Inflows to the parent

company Dividend received

+Interest received

+ Management fees

+ Royalties received for parents, licenses, brands, technology transferetc.

+Terminal cash flows(Net of taxes) such AS REPATRIATION OFSALE PROCEEDSOF PLANT, REEASE OF WORKING CAPITAL,BLOCKED FUNDS NOT PAID DUE TO EXCHANGE CONTROLRESTRICTIONS

Repayment of loanIncrease in cash profits due to increased export sales of other products at

parent MNC

Less: decrease in cash profits(after taxes) due to decrease in export sales


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Impact of taxes

The earnings are subject to tax at more than onestage as per the tax laws of many countries.

1. Taxes levied on subsidiary by local governmentwhere business is located

2.Tax on Dividends remitted to parent companyby subsidiary in the country where subsidiary is

set up. 3.Dividend received by parent company is alsotaxed as their income in the parent country.

Note:- Inorder to avoid multiple tax double

taxation agreement might help parent company to


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Example

If HP has set up its subsidiary in India where tax

rate is 20%.Assume further that corporate firms in

US are subject to tax of 35%.Tax credit is allowedin USA due to double tax agreement.

A)Determine the amount of tax credit available to

a subsidiary having remitted US$ 4 million after-

tax earnings as dividend.Answer:- Next page


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The subsidiarys before-tax earning is equivalentto $5 (ie.$4 million (1-tax rate 0.2)

Tax paid on $5 milion is 20% on $5 million is $1million

In USA tax on income is( $5 million x 0.35) $1.75million

Excess tax payable in USA is 1.75-1.0=$0.75million.

If tax rate in subsidiary country is 40%, what willbe the position?


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If tax rate in subsidiary country is 40% then

in USA the benefit is limited to 35% only.

Therefore no additional tax will be imposed.


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Exchange rate risk and capital

budgeting If currencies are devalued or appreciated it affects

capital budgeting decision as flow of funds in

future is affected due to which profitability of theproject also affected.

Take the exercise 4(slide number 24) where

subsidiary company countrys currency

depreciates every year by say 2% what are theimpacts?

The current exchange rate is Rs.43/$


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Devalued value

Year Rs/$

1 43

2 43.86

3 44.74

4 45.63

5 46.54

1.02(43)==

=

Calculator

Devaluation and cash inflows


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Devaluation and cash inflows The annual cash Inflow is (Net cash inflow per year )-

Calculated as per slide number 24 exercise number 4

net annual cash inflow $97.16 million.=Rs.4177.88

Year

(1)

CAFT

Rs(2)

Exchange

rate:

Rs(3)

$ equivalent

4=2/3

1

2

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5

5

4177.88

4177.88

4177.884177.88

4177.88

1720.00

43

43.86

44.7445.63

46.544

46.544

97.16

95.25

93.3891.56

89.77

36.95


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Calculation of Net present value$ equivalent

4=2/3

Present value

factor

Present value

97.16

95.25

93.38

91.56

89.77

36.95

0.869

0.756

0.657

0.572

0.497

0.497


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Tax planningemployees

remuneration 1.Employer and employee relationship

-Taxable to employee and deduction to employer

2. Remuneration to partner:-Payment of salary to apartner is disallowed to the firm.

3. Director/managing directors remuneration:

-Managing director is normally considered as

employee. Director is not normally considered asemployee. Managing director-salary.

Director-not a salary


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Fringe benefit tax

Section 115WA

It is payable by employer-If no employer no needto pay fringe benefit tax

Only when the employer has one or moreemployees based in India.

Benefits provided to employees or deemed to have

been provided are taxable@30%+surcharge(10%)+Educational cess(3%)-domestic company, firm and artificial juridicalperson

Foreign company-@30%+2.5%(surcharge)+3%
mailto:company-@30%+2.5%(surcharge)+3%mailto:company-@30%+2.5%(surcharge)+3%mailto:company-@30%+2.5%(surcharge)+3%mailto:company-@30%+2.5%(surcharge)+3%


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If no income tax is payable

should FBT to be payable? Yes


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Are 100% export zone, SEZ

covered under FBT? Yes


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Who are not covered under FBT?

Section 10(23C), 12AA, Political

party(29A), companies registered u/s 25

Documents

International Financial Management 1219993582593066 8