Establishing a Corporation Subsidiary
Kipanga Corporation currently has no existing business in German but it is considering establishing a subsidiary there. The following information has been gathered to assess this project: The initial investment capital required to start the project would be Euro 50 million to be used to buy plant and equipment. The plant is expected to have a useful life of 10 years and would be depreciated using a straight line method. The project would be terminated at the end of year three, when the subsidiary would be sold. Kipanga expects to receive Euros 35 million when it sells the subsidiary. This would be equal to the book value at the end of year 3. The exchange rate of the Euro is expected to be TShs 0.56 at the end of year 3. However it is estimated that the risk free interest rate in Tanzania is 12% and in German is 10%. The price, demand, and variable cost of the product in German are as follows:-
| Year | Price(Euros) | Demand | Variable Cost |
| 1 | 500 | 40,000 units | Euro 30 |
| 2 | 511 | 50,000 units | Euro 35 |
| 3 | 530 | 60,000 units | Euro 40 |
The fixed costs, such as overhead expenses, are estimated to be Euro 6 million per year. All cash flows received by the subsidiary are to be sent to the parent company at the end of each year. The German government would impose an income tax of 30%. In addition, it would impose a withholding tax of 10% on earnings remitted by the subsidiary. The Tanzanian Government would allow a tax credit on remitted earnings and would not impose any additional taxes. Kipanga requires a 20% rate of return on this project.
Required: Should Kipanga accept the project or not? Justify your answer.
Describe the mechanics of international APV method of appraising international investment. Under which circumstances might the APV be a better technique to use than NPV?
