Forecast project or organisation FCF from overseas projects

Notes

Forecasting project cash flows

When a multinational company sets up a subsidiary in another country, to which it already exports, the relevant cash flows for the evaluation of the project should take into account the loss of export earnings in the particular country. 

The NPV of the project should be:
Sum of discounted (net cash flows – exports) + discounted terminal value – initial investment 

The appropriate discount rate will be WACC.

Taxation and international investment appraisal

The following procedure can be applied:

  1. Allow for host country investment incentives (capital allowance) before applying the local tax rate to local taxable cash flows.

  2. Apply the relevant parent company rate of tax to the taxable/remitted cash flows.

  3. Adjust point 2 above for any double taxation agreement.

Consider the following:

Spain tax  UK tax 
(1) 20%  20% 
(2) 20%  30% 
(3) 20%  18% 

In (1) no further tax will be paid in the UK as profit is taxed in Spain at 20%.

In (2) profit would be taxed at 30%, 20% in Spain and a further 10% in the UK.

In (3) no further tax will be paid in the UK. The 20% is charged in Spain.

Illustration 1

Suppose that the tax rate on profits in Country 1 is 10% and the UK corporation tax is 20%, and there is a double taxation agreement between the two countries. 

A subsidiary of a UK firm operating in Country 1 earns the equivalent of £1 million in profit, and therefore pays £100,000 in tax on profits. 

When the profits are remitted to the UK, the UK parent can claim a credit of £100,000 against the full UK tax charge of £200,000, and hence will only pay £100,000.

Illustration 2

Cow Co. is considering whether to establish a subsidiary in Slovakia at a cost of €15,000,000. 

The subsidiary will run for 4 years and the net cash flows from the project are:

Net Cash Flow €
Year 1  3,000,000 
Year 2 4,500,000 
Year 3 7,000,000
Year 4  8,000,000

There is a withholding tax of 10 percent on remitted profits and the exchange rate is expected to remain constant at €1.50 = $1.

If the required rate of return is 15% what is the present value of the project?

€ after WHT Remittance $ Discount factor (15%)  Discounted $
Year 1  3,000,000  3,000,000 x 0.9 = 2,700,000 2,700,000 / 1.5 = 1,800,000 0.870  1,566,000
Year 2 4,500,000  4,500,000 x 0.9 = 4,050,000 4,050,000 / 1.5 = 2,700,000 0.756  2,041,200
Year 3 7,000,000 7,000,000 x 0.9 = 6,300,000 6,300,000 / 1.5 = 4,200,000 0.658  2,763,600
Year 4  8,000,000 8,000,000 x 0.9 = 7,200,000 7,200,000 / 1.5 = 4,800,000 0.572  2,745,600
Total 9,116,400

The NPV is $9,116,400 - EUR 15,000,000/1.5 = - $ 883,600

Notes