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1. is there a relationship with transfer pricing and the other countries government(where subsidiaries are located) ? if we charge high transfer pricing, subsidiary will pay more taxes which may contribute to that particular country’s well being so it will have better relationship with the government ?
2.is there a relationship with gearing and cost of capital ? if there’s high gearing level, does it mean that high rate of return for debt holders while for equity holders, rate of return will be much lower ?
3. irr assumes that cash flows of a project are reinvested at IRR. i dont actually quite understand after watching a video from opentuition as well. Does it basically means that all positive cashflows for each period after making an initial investment in the year 0, are all compounded together ??
1. In practice it may be a factor, but certainly not in the exam. What could be relevant (but not in calculations) is the fact that the transfer price can be used to make sure that the higher profits are made in the country with the lower tax rate. However most companies have rules on transfer prices to stop this.
2. There is an enormous relationship!!! Higher gearing does not affect (in theory) the cost of debt, but increases the cost of equity (because shareholders will want a higher return because there is more risk). According to M&M the WACC will fall with higher gearing because of the tax shield on debt.
You really must watch the Paper F9 lectures on this.3. That assumption is only relevant if we were to use the IRR to choose between projects.
A project giving a return of 10% p.a. for 3 years is not necessarily going to be better than another project giving only 9% p.a., but for 20 years. We could only say with certainty that the 10% project was better if we assumed that for both project the inflows could be reinvested at 10% or 9% for ever. In that case it would clearly be better to get 10% a year for ever than 9% a year for ever.
A way of avoiding the problem is to calculate instead the MIRR which is all explained in my free lectures.
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