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Andromeda Inc., a US-based MNC, has a wholly owned subsidiary in Brazil, Rio Inc., that manufactures microchips for biometric scanners. Rio expects 2 million sales

Andromeda Inc., a US-based MNC, has a wholly owned subsidiary in Brazil, Rio Inc., that manufactures microchips for biometric scanners. Rio expects 2 million sales units per year for the next five years.

  • Rio expects 2 million sales units per year for the next five years.
  • Rio charges 20 reais per unit (price) with the average cost per unit of 15 reais (variable cost). (All sales and costs are quoted in Brazilian real.)
  • Rio maintains account receivables at the level of 20% of sales and its inventory is also maintained at 15% of annual cost of goods sold.
  • Fixed operating expenses are expected at 1,300,000 reais per year, and annual depreciation expenses are estimated at 500,000 reais per year.
  • Rios tax rate is 30%.
  • Current spot exchange rate is US$0.46/real.
  • Andromeda has a cost of capital of 18%

a. Compute annual operating cash flows for Rio for the next five years. And, calculate PVs for cash flows (US$) for the next five years using the cost of capital given. Assume that the exchange rate stays the same at the current rate of US$0.46/real between year 1 and year 5.

b. Suppose the spot exchange rate between US$ and Brazilian real suddenly changes to US$.38/real. And the real depreciation results in an increase in demand for Rios products so that the company might increase its unit sales by 50% by keeping the real-denominated price at 20 reais per unit. Everything else remains the same. Recalculate cash flows (US$) and compute changes in PVs of cash flows (US$) for next five years using the cost of capital given. Assume that the exchange rate stays at $.38/real rate between year 1 and year 5. Also, assume that increase in working capital is financed in year 1 and recovered in year 5

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