1. Assume that a less developed country called LDC encourages direct foreign investment (DFI) in order to reduce its unemployment rate, currently at 15 percent. Also assume that several MNCs are likely to consider DFI in this country. The inflation rate in recent years has averaged 4 percent. The hourly wage in LDC for manufacturing work is the equivalent of about $5 per hour. When Piedmont Co. develops cash flow forecasts to perform a capital budgeting analysis for a project in LDC, it assumes a wage rate of $5 in year 1 and applies a 4 percent increase for each of the next 10 years. The components produced are to be exported to Piedmont's headquarters in the United States, where they will be used in the production of computers. Do you think Piedmont will overestimate or underestimate the net present value of this project? Why? (Assume that LDC's currency is tied to the dollar and will remain that way.)

The net present value will likely be ___(overestimated, underestimated) because the labor costs in LDC will probably increase at a ___ (higher, lower) rate than 4 percent per year. DFI in LDC will cause the demand for labor to rise ___ (much greater, slightly) than in previous years.

2. PepsiCo recently decided to invest more than $300 million for expansion in Brazil. Brazil offers considerable potential because it has 150 million people and their demand for soft drinks is increasing. However, the soft drink consumption is still only about one-fifth of the soft drink consumption in the United States. PepsiCo's initial outlay was used to purchase three production plants and a distribution network of almost 1,000 trucks to distribute its products to retail stores in Brazil. The expansion in Brazil was expected to make PepsiCo's products more accessible to Brazilian consumers.

Given that PepsiCo's investment in Brazil was entirely in dollars, describe its exposure to exchange rate risk resulting from the project. Explain how the size of the parent's initial investment and the exchange rate risk would have been affected if PepsiCo had financed much of the investment with loans from banks in Brazil.

A) As the earnings in Brazil are remitted, they will be converted to dollars. If Brazil's currency depreciates against the dollar over time, there will be ___ (less, more) dollar earnings received. If PepsiCo borrowed funds from banks in Brazil, the parent's initial investment would have been ___(smaller, larger). The payments by the subsidiary

B) PepsiCo's parent was responsible for assessing the expansion in Brazil. Yet PepsiCo already had some existing operations in Brazil. When capital budgeting analysis was used to determine the feasibility of this project, should the project have been assessed from a Brazilian perspective or a U.S. perspective? Explain.

Since the PepsiCo's parent uses its own funds to support expansion, the project should have been assessed from a ___ (Brazil, US, Brazil and US) perspective.