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ACCA Strategic Professional · Advanced Financial Management · Dividend policy in multinationals and transfer pricing

A parent's subsidiary has blocked funds of 2,000,000 that cannot be remitted for 3 years. The parent's cost of capital is 10% and the discount factor for year 3 is 0.751. The funds can be invested locally at 4% per year compounded, with the proceeds released at the end of year 3 (1.04^3 = 1.125). Ignoring tax, which statement about the value to the parent is correct?

The blocked funds are worth about 1,690,000 to the parent. They grow at 4% to 2,250,000 after three years and are then discounted at the parent's 10% cost of capital using the 0.751 factor. Ignoring local interest or the delay in release gives wrong values.

  1. AThe present value is about 1,690,000, being 2,000,000 × 1.125 × 0.751Correct
  2. BThe present value is 2,000,000 because the funds belong to the parent
  3. CThe present value is about 1,502,000, because blocked funds should be discounted without any local interest
  4. DThe present value is about 2,250,000, being the compounded amount without discounting

Explanation

Local investment grows to 2,000,000 × 1.125 = 2,250,000 at year 3. Discounting at the parent's 10%: 2,250,000 × 0.751 = 1,689,750, about 1,690,000. Ignoring local interest gives 1,502,000, which understates value. Not discounting overstates it.

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