International

Investment Appraisal
Forecasting Exchange Rate
Purchasing Power Parity
S1 = So x [(1+inflation rate of 1st currency)/ (1+inflation rate of 2nd currency)]
EXAMPLE:The Current Dollar Sterling exchange rate is given $/£ 1.7050
Expected Inflation Rates are:
Year USA UK
1 5% 2%
2 3% 4%
3 4% 4%
Find the expected spot rate for next three years.
SOULTION:
Year Calculation Future Expected Spot
Year 1 1.7050 x (1.05/1.02) 1.7551
Year 2 1.7551 x (1.03/1.04) 1.7382
Year 3 1.7382 x (1.04/1.04) 1.7382
©ACCA
Impact of Taxation
The level of taxation on a project’s profits will depend on the relationship between the tax rates in the home
and overseas country.
The question will always assume a double-tax treaty  project always taxed at higher rate.

EXAMPLE:
What will be the rate of tax on a project carried out in the US by a UK company in each of the
following scenarios? Parent co is in UK
Scenario'
UK TAX US TAX
s
A 33% < 40%
B 33% = 33%

C 33% > 25%

Scenario A – No further UK tax to pay on the project’s $ profits. Profits taxed at 40% in US.
Scenario B – No further UK tax to pay on the project’s $ profits. Profits taxed at 33% in US.
Scenario C – Project’s profits would be taxed at 33%. 25% in US and further 8% tax payable in
the UK on gross USA earnings

©ACCA
Inter-Company Cash flows
Inter-company cash flows, such as transfer prices( inter company transactions), royalties and management
charges, can also affect the tax computations.
Example: A project carried out by a US subsidiary of a UK company is due to earn revenues of $100m in the US in
Year 2 with associated costs of $30m. Royalty payments of $10m will be made by US subsidiary to UK. Assume tax
is paid at 25% in the US and 33% ; and assume a forecast $/£ spot rate of $1.50/£.
What are the cash flows associated with the project?
Year 2 $m UK Tax Computation:
Revenues 100
UK Tax on $ profits – 33% - 25% =8%
Costs (30)
Royalties (10) 8% UK tax on $ profits: $60m/1.50 = £40m
: £40m x 0.08 = £3.2m
Pre-Tax profit 60 33% UK Tax on Royalties = £6.7m x 0.33 = £2.2m
25% US Tax (15)
** UK TAX PAYABLE : £ 5.4m
Remit to Parent 45*
£ Cash Flow 30 - *45/1.50
Royalties 6.7 $10m/1.50
UK Tax (5.4)**
©ACCA
After Tax Cash £31.3m
flow
Remittance Restriction
Remittance occurs where an overseas government places a limit on the funds the can repatriated
back to the holding company.
This restriction will change the cash flows that are received by the holding company.
Example:
A project’s after US-tax $ cash flow is as follows ($m):
YEAR 0 1 2 3
(10) 3 4 6
In any one year, only 50% of cash flows generated can be remitted back to the parent. The blocked funds can be
released back to parent in the year after the end of project

Q. Identify the cash flows to be evaluated?

YEAR 1 2 3 4
Net Cash Flow 3 4 6
Blocked Funds (1.5) (2) (3)
Remit to Parent (Final 1.5 2 3 6.5
Cash flows)
©ACCA
Standard Proforma for International Investment Appraisal