FINC 5340 Homework 8

FINC 4080 (4340) Spring 2015 Homework 10

As the newly hired financial analyst for Rodgers International, you are charged with evaluating a possible investment by the firm in Bolivia. It is the end of 2014 (year 0) and an idle Bolivian facility is available to be purchased at a price of 25,000,000 Bolivian Boliviano (BOB).Rodgers is currently exporting twitters to Bolivia and expects to export 15,000 units next year (2015, or Year 1) at a price of BOB 400 per unit with future demand for exported twitters expected to grow at 5 percent per year thereafter; besides the expected growth in the number of twitters exported, future prices of exported twitters are expected to increase by 2 percent per year. Sales of exported twitters yields the firm an after-tax profit margin of 20 percent. However, buying the Bolivian facility would eliminate these export sales and replace them with new local sales that are expected to be 30,000 units in 2015, maintaining the same BOB 400 sales price. Future Bolivian demand for locally-produced twitters is expected to grow at 7 percent per year with future price increases of domestically-produced twitters expected to average 8 percent per year in Bolivian boliviano terms.The variable cost of producing twitters in Bolivia is forecasted to be BOB 100 per unit in the first year of operations (2015) with such costs growing at an average rate of 3 percent per year thereafter. Fixed costs, other than depreciation, are expected to be BOB 2,000,000 in 2015, with future costs growing at the general level of inflation of 8 percent per year thereafter. Depreciation of the facility will follow Bolivian guidelines of 5 years, straight-line of the total BOB 25,000,000 investment. (Disregard the expected salvage value when calculating the annual depreciation expense of the facility).The Bolivian and U.S. tax rates are each 40 percent. Rodgers expects to annually remit 100 percent of the cash flows generated by the project back to the parent. Although uncertain, the firm believes that it will be able to resell the company to local investors for an after-tax amount of BOB 15,000,000 after three years of operations (i.e., the expected salvage value).The current exchange rate is BOB/USD 6.3300 with future exchange rate changes expected to follow purchasing power parity; the inflation rate is expected to remain at 8 percent per year over the next three years in Bolivia and 5 percent per year in the U.S. In evaluating foreign investments Rodgers typically uses a discount rate of 15 percent. However, because of special financing through the Inter-American Development Bank, a discount rate of 12 percent is deemed to be more appropriate.

1.aShould Rodgers make this investment, and explain why or why not?

b.Assume the same facts as above except that Rodgers is unsure about the salvage value of the investment. How much would Rodgers need to receive from selling the operations at the end of year three to make this a viable project? That is, what is the minimum salvage value (in BOB terms)?

c.Assume the same situation as in part 1, except that now there is an Argentine competitor that is planning to invest in Bolivia, but only if Rodgers chooses not to make the investment. If the competitor makes the investment, Rodgers is expected to lose its entire export market in South America. All of the original information from part 1 should be assumed to remain the same. How does this new assumption affect your analysis? Would you recommend making the investment under these circumstances?

d.Assume the same situation as in part 3. Despite the current inflation rate differential between the two countries the corporate treasurer at Rodgers has made a forecast in which she expects the Bolivian boliviano will depreciate against the U.S. dollar by 5 percent per year over the next three years. How does this new assumption affect your analysis? Would you recommend making the investment under these circumstances?