TQ1. GULF COMPANY

Annual fixed costs (excluding depreciation), are forecast at TZS 80,000,000. As per agreement

Gulf Company is an Italian based manufacturer of radios. The company’s senior management

year’s after tax accounting profit. Cash remitted to Italy from the subsidiary is not taxable in

1400/Euro. Corporate tax in Tanzania is 30%, in Italy 40%. Tax is payable, and allowances are

TANZANIA 6%. The cost of capital for the company is 10%. The spot exchange rate is TZS

subsidiary would involve construction of a new factory in Dar es Salaam. The initial project

between Gulf Company and the authorities in Tanzania, depreciation expenses are not tax

investment and thus allows overseas investors to repatriate an annual cash dividend equal to that

per radio is estimated as follows:

market and wish to set up a manufacturing subsidiary in Tanzania. Setting up the Tanzanian

team has believed for several years that there is an opportunity to increase sales in the domestic

Working capital requirementsEuro 100,000

Production and sales are expected to be constant at 20,000 units per annum. The average price

Year 3:TZS 56,000

The variable cost ratio is forecast at 30% of the selling price and is expected to remain constant.

Fixed assetsEuro 900,000

cash investment is estimated at Euro 1,000,000 divided as follows:

Italy. The after tax realizable value of the investment in four years’ time is expected to be

Year 2:TZS 53,000

allowable. Inflation for each economy in the next four years is expected to be: ITALY 4%,

Year 1:TZS 55,000

Year 4:TZS 59,000

available, one year in arrears. The government of Tanzania is anxious to encourage foreign

approximately TZS 200 million.

Required:Evaluate whether Gulf Company should establish the Tanzanian Subsidiary 

Sample Solution

To evaluate whether Gulf Company should establish the Tanzanian subsidiary, we need to calculate the net present value (NPV) of the project. NPV is the difference between the present value of the cash inflows and the present value of the cash outflows, discounted at the cost of capital.

First, we need to convert the fixed costs and the working capital requirements into Tanzanian shillings using the spot exchange rate.

Fixed costs (excluding depreciation): TZS 80,000,000 / 1400 = Euro 57,142.86 Working capital requirements: Euro 100,000 * 1400 = TZS 140,000,000

Next, we need to calculate the expected sales revenue in Tanzanian shillings for each year…Order a customized and more comprehensive answer here