CA FINAL COURSE

STRATEGIC FINANCIAL MANAGEMENT

Chapter-10

Total Marks: 15

Q-1 XYZ Ltd., a company based in India. Manufactures very high quality modem furniture and
sells to a small number of retails outlets in India and Nepal. It is facing tough competitions.
Recent studies on Marketability of products have clearly indicated that the customer is now
more interested in variety and choice rather than exclusively and exceptional quality. Since the
cost of quality wood in India is very high, the company is reviewing the proposal for import of
woods in bulk form Nepalese supplier.

The estimate of net Indian (Rs) and Nepalese Currency (NC) cash flows in Nominal terms for this
proposal is shown below:

Year Net Cash Flow (in millions)

0 1 2 3
NC -25.000 2.600 3.800 4.100
Indian (Rs) 0 2.869 4.200 4.600

The following information is relevant:

i. XYZ Ltd. evaluates all investments by using a discount rate of 9% p.a. All Nepalese
customers are invoiced in NC. NC cash flows are converted to Indian (Rs.) at the forward
rate and discounted at the India rate.

ii. Inflation rates in Nepal and India are expected to be 9% and 8% p.a. respectively.

The current exchange rate is Rs. 1 = NC 1.6 Assuming that you are the finance manager
of XYZ Ltd., Calculate the net present value (NPV) and modified internal rate of return
(MIRR) of the proposal.

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You may use following values with respect to discount factors for Rs. 1@9%.

Present value Future value

Year 1 0.917 1.188
Year 2 0.842 1.090
Year 3 0.772 1
(5 Marks)

Q-2 Opus Technologies Ltd., an Indian IT Company is planning to make an investment through a
wholly owned subsidiary in a software project in China with a shelf life of two years. The
inflation in China is estimated as 8 percent. Operating cash flows are received at the year end.

For the project an initial investment of Chinese Yuan (CN¥) 30, 00,000 will be in a piece of land.
The land will be sold after the completion of project at estimated value of CN¥ 35,00,000. The
Project also requires an office complex at cost of CN¥ 15, 00,000 payable at the beginning of
project. The complex will be depreciated on straight-line basis over two years to a zero salvage
value. This complex is expected to fetch CN¥ 5, 00,000 at the end of project.

The annual sale is expected to be 10,000 units at the rate of CN¥ 500 per unit. The price of unit
is expected to rise at the rate of inflation. Variable operating costs are 40 percent of sales.
Current fixed operating costs are CN¥ 22, 00,000 per year which is expected to rise at the rate
of inflation.

The tax rate applicable in China for business income and capital gain is 25 percent and as per
GOI Policy no further tax shall be payable in India. The current spot rate of CN¥ 1 is Rs 9.50. The
nominal interest rate in India and China is 12% and 10% respectively and the international
parity conditions hold.

You are required to

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 (a) Identify expected future cash flows in China and determine NPV of the project assuming
that there is a restriction on transfer of funds from China to India as the same can be
done only at the end of year2.

(b) Determine whether Opus Technologies should go for the project or not assuming that
there is no restriction on transfer of funds from China to India.

(5 Marks)

Q-3 A foreign based company is planning to set up a software development unit in India.
Software developed at the Indian unit will be bought back by the foreign parent company at a
transfer price of US $ 10 million. The unit will remain in existence in India for one year; the
software is expected to get developed within this time frame.

The foreign based company will be subject to corporate tax of 30 per cent and a withholding tax
of 10 per cent in India and will not be eligible for tax credit. The software developed will be sold
in the international market for US $12.0 million. Other estimated are as follows:

Rent of fully furnished unit with necessary hardware in India Rs. 20,00,000
Man power cost (80 software professional will be working for 10 hours Rs. 540 per man
each day) hour
Administrative and other costs Rs. 16,20,000
The rupee-dollar rate is Rs. 65/$.

Advise the foreign company on the financial viability of the project.

Assumption: 365 days in a year.

(5 Marks)

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