Read the case given below and answer the questions given at
the end.
Krutika Designers Ltd is an Indian company engaged in
designing shirts for an international shirt manufacturer.
Its operations are currently restricted to designing shirts
for the Indian market. The firm is interested in extending
its operations to the European markets, but is restricted
by its lack of knowledge about the latest fashions and
trends prevailing there. Hence, the firm has decided to
open an office in Finland for establishing a network in
Europe that will give the firm access to the needed
information. The firm feels that its does not have the
capability of sustaining itself in the foreign markets in
the long-term, and will be able to generate additional
revenue from these activities only for the next 5 years.
After that, the Finnish office will have to be closed down.
The firm anticipates an initial investment of Rs.14
million. The project is expected to generate the following
cash flows over the 5 years period.
Year Cash flow (Finnish Marks)
1
2
3
4
5 10,00,000
20,00,000
50,00,000
50,00,000
30,00,000

These cash flows are expressed in terms of today’s money.

The firm can claim depreciation in India according to the
Straight Line Method. The salvage value from the project
is expected to be nil.

The Finnish Government does not provide any incentives for
foreign investments. However, currently it is making an
attempt to have better economic ties with India. Hence, it
has decided to extend a loan of 50,000 marks to Krutika
Designers. The loan will be at a concessional interest
rate of 7%. The loan is to be repaid in 5 equal annual
installments which will include the interest payments.

The project will generate additional borrowing capacity of
Rs.5 million for the firm. However, as the firm does not
have any firm contract with the international shirt
manufacturer, its domestic revenues are expected to be very
volatile. Therefore, there is no surely that the firm will
be able to absorb the tax benefits arising out of
depreciation and additional borrowing capacity.

The firm does not intend to indulge in any illegal money
transfers.

The current spot rate for the Finnish Mark is Rs.7.25/FM.
The inflation rates in India and Finland for the next 5
years are expected to be 8% and 3% respectively. The
exchange rate is expected to move in tandem with the
inflation rates.

Indian tax rate is 35% while Finnish tax rate is 40%.
India and Finland have entered into a tax treaty whereby
the earnings of the residents of one country are taxable in
that country only.

In India, the nominal risk-free interest rate is 11%. The
same is 6% in Finland. The Indian nominal interest rate
(including risk-premium) is 15%, while that in Finland is
9%. The nominal all-equity rate in India is 18%.

1. Comment on the financial viability of the project.
2. What are the different circumstances in which
nominal all-equity discount rate and real all equity
discount rate should be used for discounting the cash
flows? Explain the rationale behind it.
3. Comment on the financial viability of the project
if the firm is sure about being able to absorb the tax
benefits arising out of depreciation and increased
borrowing capacity.
4. Explain the concept of exchange risk and how it
affects an international project.
5. How can the financial structure of a project be
used to overcome repatriation restrictions? What are the
additional benefits of such maneuvers?