Fiat— an Italian auto firm— signs a production agreement with Tata— an Indian firm— to manufacture a local version of its Uno car. Under the terms of the agreement, Fiat would share its small car technology. Tata contributes its production capacity as well as distribution systems. Fiat is affected by the following terms of the agreement: Initial investment. Fiat does not make any cash investment. It provides only its IP. The JV does not have any capital equipment on its books and, hence, there is no depreciation or salvage value. Revenues. Over each of the project’s five years, the JV expects to sell 120,000 cars at a price of Indian rupees (INR) 1 million each. Expenses. The JV incurs direct costs of production and distribution of INR 0.7 million per car. Tata, not the JV, bears indirect costs. Payments to Tata. Tata bears the fixed cost of production and distribution, but the JV pays Tata 5 percent of revenues as compensation. Share of profits. The JV repatriates 30 percent of profits to Fiat each year. Other data. Spot EURINR equals 65. Assume that the INR is expected to depreciate by 1.5 percent a year. Fiat’s cost of capital is 9 percent. Assume Indian corporate income taxes of 25 percent with withholding taxes of 5 percent. Also assume that there are no additional Italian taxes. What are the JV’s profits each year?
| In Millions | |||
| Sales Price of cars sold | 120000 | ||
| Cost of production and distribution | 84000 | ||
| Payment to TATA on account of bearing fixed expences (% of 120000 million) | 6000 | ||
| Profits of project each year | 30000 | ||
| Share of Fiat in profits (30000x30%) | 9000 | ||
| Less Tax 25% | 2250 | ||
| Profit after tax | 6750 | ||
| Exchange Rate Year at present | 65 | ||
| Exchange rate Year 1 (65+1%) | 65.65 | ||
| Profits in Euro for year 1 | 102.81797 | ||
| Exchange rate Year 2 (65.65+1%) | 66.66 | ||
| Profits in Euro for year 2 | 101.26013 | ||
| Exchange rate Year 3 (66.66+1%) | 67.33 | ||
| Profits in Euro for year 3 | 100.25755 | ||
| Exchange rate Year 4(67.33+1%) | 68.00 | ||
| Profits in Euro for year 4 | 99.264901 | ||
| Exchange rate Year 5(68+1%) | 68.68 | ||
| Profits in Euro for year 5 | 98.282081 |
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