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 2012 (year 0) and an idle Bolivian facility is available to be purchased at a price of 28,000,000 Bolivian Boliviano (BOB).
Rodgers is currently exporting twitters to Bolivia and expects to export 25,000 units next year (2013, or Year 1) at a price of BOB 280 per unit with future demand for exported twitters expected to grow at 10 percent per year thereafter; future prices of exported twitters are expected to increase by 2 percent per year. Export sales yield the firm an after-tax profit margin of 12 percent. However, buying the Bolivian facility would eliminate these export sales and replace them with new local sales expected to be 60,000 units in 2012, maintaining the same BOB 280 sales price. Future Bolivian demand for locally-produced twitters is expected to grow at 15 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 140 per unit in the first year of operations (2013) with such costs growing at an average rate of 3 percent per year thereafter. Fixed costs, other than depreciation, are expected to be BOB 2,100,000 in 2013, 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 28,000,000 investment. (Disregard the expected salvage value when calculating the annual depreciation of the facility).
The Bolivian and U.S. tax rates are each 34 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 14,000,000 after three years of operations (i.e., the expected salvage value).
The current exchange rate is BOB/USD 7.00 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 Rogers typically uses a discount rate of 15 percent. However, because of various assurances the company has received from the Bolivian government and the Inter-American Development Bank, a discount rate of 8.5 percent was deemed to be more appropriate.
1. Should Rodgers make this investment, and explain why or why not?
2. 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 BOBterms)? How could this information be useful in the decision to invest or not to invest?
3. Assume the same situation as in part 1, except that now there is an Argentinecompetitor that is planning to invest in Bolivia, but only if Rodgers chooses not to make the investment. If the competitor makes the investment, Rodgersis 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?
4. Assume the same situation as in part 3. Despite the current inflation rate differential between the two countriesthe corporate treasurer at Rodgershas made a forecast in which she expects the Bolivian boliviano to depreciate against the U.S. dollar by 1% per year over the next three years. How does this new assumption affect your analysis? Would you recommend making the investment under these circumstances?
5. Assume the same situation as in part 3 except that the Bolivian government is politely suggesting that Rodgers should invest the cash flows it generates from the project in a Bolivian government fund yielding an after-tax return of 3 percent per year. After three years, the full amount of the funds would be available for withdrawal by Rodgers, along with the salvage value proceeds from the project itself. How would this information affect your analysis of the project from both a quantitative and qualitative basis? Would you recommend making the investment under these circumstances?