DFG projects that it will operate the foreign subsidiary for 10 years (years 0 through 9) and that the terminal value of the operation at the end of this period will be the same regardless of location. Assuming a 6 percent discount rate, determine which location maximizes the NPV of the foreign operation.

FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
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Chapter1: Financial Statements And Business Decisions
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B9.

 

Question 1
Firm DFG plans to open a foreign subsidiary through which to sell its manufactured goods in the
European market. It must decide between locating the subsidiary in Country A or Country B. If
the subsidiary operates in Country A, its gross receipts from sales will be subject to a 3 percent
gross receipts tax. If the subsidiary operates in Country B, its net profits will be subject to a 42
percent income tax. However, Country B's tax law has a special provision to attract foreign
investors: No foreign subsidiary is subject to the income tax for the first three years of operations.
DFG projects the following annual operating results for the two locations (in thousands of
dollars):
Gross receipts from sales
Cost of sales
Operating expenses
Country A
$220,000
120,000
44,000
Country B
$220,000
120,000
30,000
DFG projects that it will operate the foreign subsidiary for 10 years (years 0 through 9) and that
the terminal value of the operation at the end of this period will be the same regardless of
location. Assuming a 6 percent discount rate, determine which location maximizes the NPV of
the foreign operation.
Transcribed Image Text:Question 1 Firm DFG plans to open a foreign subsidiary through which to sell its manufactured goods in the European market. It must decide between locating the subsidiary in Country A or Country B. If the subsidiary operates in Country A, its gross receipts from sales will be subject to a 3 percent gross receipts tax. If the subsidiary operates in Country B, its net profits will be subject to a 42 percent income tax. However, Country B's tax law has a special provision to attract foreign investors: No foreign subsidiary is subject to the income tax for the first three years of operations. DFG projects the following annual operating results for the two locations (in thousands of dollars): Gross receipts from sales Cost of sales Operating expenses Country A $220,000 120,000 44,000 Country B $220,000 120,000 30,000 DFG projects that it will operate the foreign subsidiary for 10 years (years 0 through 9) and that the terminal value of the operation at the end of this period will be the same regardless of location. Assuming a 6 percent discount rate, determine which location maximizes the NPV of the foreign operation.
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