Page 63 - AFM Integrated Workbook STUDENT S18-J19

International operations and international investment appraisal

Illustration 3

Blood Co is a European company. It is considering setting up a subsidiary in
Blueland (where the currency is the Blue dollar (B$)) in order to invest in a
new project. Revenues and costs in the first year of operation are expected to
be B$80 million and B$30 million respectively. The Blueland subsidiary will
pay a management charge of B$10 million to the European parent company
each year.

The rate of tax is 10% in Blueland and 25% in Europe. The expected
exchange rate in one year’s time is B$5 = €1.

Required:

Forecast the project’s free cash flow in the first year, in Euros (€).

Solution

Year 1 FCF B$ m

Revenue 80

Costs (30)

Mgt charge (10)

Pre-tax profit 40

10% Blueland tax (4)

Remit to parent 36

(translated into €) B$5 = €1

€ (million) cash flow 7.2

Mgt charge (B$10m / 5) 2

Tax on mgt charge (25%) (0.5)

Extra European tax (15% x B$40m / 5) (1.2)

Free cash flow €7.5m

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