Reference no: EM131317284
A company exports 37,000 products to Chile under an import license that expires in five years. In Chile, the products are sold for the Chile peso equivalent of $45. Direct shipping costs in the United States and indirect costs together amount to $15 ($10 and $5 per set respectively), expected to grow at US inflation. The material cost in Chile cost in Chile equals $15, this cost is expected to grow at Chilean inflation. The market for this type of gasket in Chile is stable, neither growing nor shrinking, and Haute holds the major portion of the market.
The Chilean government has invited Haute to open a manufacturing plant so products can be produced locally. If Hermosa makes the investment of 7,000,000 pesos ($2,000,000), it will operate the plant for five years and then sell the building and equipment to Chilean investors at a price of 6 times ending sales. The cost of the depreciable assets is 6,000,000 and 1,000,000 is needed in carrying inventory; assume a straight-line depreciation and five year life of the assets. Haute will be allowed to repatriate all net income to the United States each year.
A company executive, wants the project evaluated in Chilean peso (Ps) then converted to the U.S. in dollars. They believes the correct method is to use the end-of-year spot rate in 2016 of Ps3.50/$ and assume it will change in relation to purchasing power. (the board is assuming U.S. inflation to be 2% per annum, Chilean inflation to be 4.5% per annum). To help offset the anticipated decline in the value of the peso, the firm plans increasing the dollar value of the item at a rate of 6% per year. They also believes that Haute should use a risk-adjusted discount rate in Chile, which reflects Chilean capital costs 20% (the estimate), and a risk-adjusted discount rate for the parent viewpoint capital budget, 19%, on the assumption that international projects in a risky currency environment should require a higher expected return than other lower risk projects. Evaluate the proposed investment; assume taxes on this project will be 40% of net income. The executive asks you to draft a project viewpoint capital budget and a parent viewpoint capital budget. What do you conclude from your analysis?
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