Establishing a Manufacturing Unit
Arrec International Company is a South African Company. The Company is considering establishing a manufacturing unit to produce TV sets in Tanzania which has been the main destination for its exports over the last five years. Setting up of the manufacturing plant will involve an immediate investment outlay SAR 10 million. The plant is expected to have a useful life of 5 years with no salvage value. For taxation purposes, the company has to follow the straight line method of depreciation. To support the investment in Tanzania, an additional working capital of TZS 100,000,000 is needed. Other relevant information on the project follows:
Land TZS8,000,000
Production per annum 1,000 units
Variable cost per unit TZS200,000 of which:
Raw Materials per unit TZS50,000
Labor TZS100,000
Overheads TZS50,000
Other Fixed Costs per annum TZS200,000,000
Selling Price per Unit TZS700,000
The South African is subjected to 40% corporate tax rate in Tanzania and its cost of capital is 20 per cent. The exchange rate between the TZS and SAR has been very volatile due to unstable interest rate policies in the two countries. The current exchange rate between the TZS and the SAR is TZS50/SAR. Interest rates are expected to be as follows in the next five years:
Year Tanzania South Africa
1 5% 6%
2 7% 6%
3 6% 5%
4 8% 6%
5 10% 8%
South Africa imposes no taxes on cash profit remitted from abroad.
Required
Assuming that all profits can be repatriated, advise Arrec regarding the financial viability of the proposal.
Capital budgeting analysis for a foreign project, like the one proposed by Arrec International Co. above, is considerably more complex than the domestic case i.e. if the company were to invest in its domestic country. Outline the main reasons contributing to increased complexity in evaluating foreign projects.
