3. What discount rate would you use to discount the Brazilian Real cash flows from the project? Does this adequately capture the risk of investing in Brazil? 4. What is the present value of the cheap financing being provided by the Japanese equipment manufacturer? How, if at all does this change the valuation of the project? 3. Note the value of the cheap financing should be added to the Br R value that you calculated above. For this calculation you should use the interest rate differential cited in the case. Namely, the normal Japanese interest rate of 3.5% vs the rate being charged to the Brazilian project. That is a differential of 3% (3.5% - 0.5%). Hence the normal combined interest / principal payment to be made on the financing of 80% of the 30 million Br Reals would be 191,360,000 Yen per year for five years. But under the manufacturers cheap financing deal, the combined interest / principal payment will be only 175,401,000 Yen per year. You should calculate the PV of this yearly cash flow saving in Japanese Yen then convert to Br R using the exchange rates in case Exhibit 2. Note, the discount rate for this calculation will be 3.5%. 4. You should compare the value of the base case first to the cost of the project in Reals. Note the initial cost of the project is reduced by the immediate tax benefit created by being able to deduct the training expenses immediately. Building and site preparation Employee training/development Production assembly equipment R$10 billion R$6 billion R$20 billion Financial Justification The new facility will enable us to expand production by 200,000 units in the first year, rising to 270,000 units in the fifth year. The detailed numbers are presented in Exhibit 1, entitled Project Evaluation. In the investment outlay of R$36 billion we have allocated R$6 billion to the acquisition and training of a skilled workforce. This should obviate the kind of problem we have experienced in bringing our existing production line up to present efficiency. The training expenditure can be expensed for taxes (it can not be amortized). The remaining R$30 billion will be depreciated on a straight-line basis over five years to zero salvage value for taxes. The cashflow projections are developed in Exhibit 1 and below are several of the more important assumptions used in these projections. Pricing of the motors reflects a movement to a more attractive before-tax margin on sales of 12 per cent. The prices are set based on the original expected revenues in costs determined in U.S. dollars and then converted to Brazilian Real. Price increases over the project lifetime are forecasted to be at the Brazilian rate of inflation to accommodate for the changes in market prices. The inflation in Brazil over this period is estimated to be eight per cent per annum. Although the building has an expected life of 20 to 30 years, the equipment will likely become physically and technologically obsolete in approximately five years. Consequently, we have chosen a five-year horizon for analysis. A salvage value of R$10 million in the fifth year is assumed for the building and the remaining equipment at that time. Based on discussions with Brazilian tax authorities, we believe that income taxes on this project will be approximately 25 per cent. However, consistent with Chicago's requirements, and in the interests of conservatism, we have used the higher U.S. rate, which we estimate to be 40 per cent. This is the tax rate Wiley Chicago would pay if it repatriated all of the investment's profits. Given the rate of Wiley's expansion in Brazil, we do not, however, feel all profits would be repatriated, so this is a conservative assumption for the tax rate that would apply to the profits from this project. Consequently, the after-tax cost of the project is R$30 billion for the plant and equipment plus the after-tax cost of training (60 per cent of the R$6 billion training cost). Project Financing Our discussions with Japanese equipment suppliers indicate that, as part of purchase of their production equipment, we will be able to finance 80 per cent of the project with a five-year uniform pay down loan denominated in yen at an interest rate of 0.5 per cent. (See Exhibit 2, entitled Project Financing, for details.) This is well below the yen borrowing rate of 3.5 per cent experienced by companies comparable to Wiley in Japan, and is certainly below the six per cent it cost the company recently to borrow intermediate term in New York. The suppliers explained the reason for the low financing rate. The sale would qualify for Japanese Bank loan guarantees and the suppliers appear to have cut the interest rate even further as a covert price reduction. Our technical people assure us the Japanese equipment is as good as any available, and it is available at an attractive "all-in price. Consequently, this provides this project with a very low cost of capital relative to alternative investment opportunities. od "ase induction, ou Exhibit 2 PROJECT FINANCING Value of Loan (in R$) Value of Loan (in ) 24.000 864,000 2001 Annual Loan payments (interest and principal) 2002 Y175,400.6 2003 Y175,400.6 2004 Y175,400.6 2005 Y175,400.6 Y175,400.6 Note: Loan payments are determined such that they are equal payments consisting of interest and principal repayment over the five-year period assuming an interest rate of 0.5 per cent per annum. Exhibit 3 CURRENT FINANCIAL INFORMATION Inflation Rate (% per annum) Exchange rate (per US$) Exchange rate ( per FC) Interest Rate (% per annum) 8.0 36/R$1 Brazil Japan | United States R$2.8/US$1 101 /US$1 -0.5 *17.0 3.5 7.5 3.0 101/US$1 * For loans backed by U.S. dollar-denominated assets, the interest rate is 12 per cent per annum