C D E F G H I J K L M N O Hermosa Components: Baseline Analysis Hermosa Beach Components, Inc., of California exports 24,000 sets of low-density light bulbs per year to Argentina under an import license that expires in five years. In Argentina the bulbs are sold for the Argentine peso equivalent of S60 per set. Direct manufacturing costs in the United States and shipping together amount to $40 per set. The market for this type of bulb in Argentina is stable, neither growing nor shrinking, and Hermosa holds the major portion of the market. 10 The Argentine government has invited Hermosa to open a manufacturing plant so imported bulbs can be replaced by local production. If Hermosa makes the investment, it will operate the plant for five years and then sell the building and equipment to Argentine investors at net book value at the time of sale plus the value of any net working capital. (Net working capital is the amount of current assets less any portion financed by local debt.) Hermosa will be allowed to repatriate all net income and depreciation funds to the United States each year. Hermosa traditionally evaluates all foreign investments in U.S. dollar terms. 16 Evaluate the proposed investment in Argentina by Hermosa Components (US). Hermosa's management wishes the baseline analysis to be performed in U.S. dollars (and implicitly also assumes the exchange rate remains fixed throughout the life of the project). Create a project viewpoint capital budget and a parent viewpoint capital budget. What do you conclude from your analysis? 18 19 20 21 22 23 24 25 26 27 Assumptions Light bulb export volume to Argentina, per year Sales price per set in Argentina Material costs per set in Argentina Material and shipping costs of imports per set Direct & indirect cost per set Depreciable investment buildings & equipment) Initial investment in net working capital Discount rate in Argentina Value 24,000 $ 60.00 20.00 $ 10.00 5.00 $ 1,000,000 $ 1,000,000 15.00% Growth 0.00% 0.00% 0.00% 0.00% 0.00% 28 B N 0 1 4 C D E F G H I J K L M Project Year Year 2013 2014 2015 2016 The capital budgeting analysis needs to be performed on both the Project Level (Project Viewpoint) and the Parent Level (Parent Viewpoint). O 2017 2012 31 32 33 Project Cash Flows in Argentina: Project Viewpoint Annual units sold (sets) Sales price in Argentina per set 24,000 60.00 36 S 37 38 39 40 41 42 Sales revenue Less direct manufacturing and shipping costs Less cost of US components @ $10/set Gross profit Less depreciation Pre-tax profit Less 40% Argentine taxes Net income Add back depreciation Annual project cash flow Return of net working capital Initial investment, total Free cash flow for discounting $ 1,440,000 (480,000) (240,000) 720,000 (200,000) 520,000 (208,000) 312,000 200.000 512,000 44 45 46 47 48 49 50 40% (2,000,000) S (2,000,000) $ 512,000 Internal rate of return (IRR) Net present value (NPV) C D E F G H I J K L The Parent Viewpoint needs to consider all incremental cash flow impacts including loss on export sales to Argentina (current practice). M N O 56 57 58 59 $ 60 Cash Flows to Hermosa in US: Parent Viewpoint Sales revenue on exports to Argentina Less direct and indirect costs on exported sets Profit on Hermosa's component sales Less US taxes on component profits @ 40% a) Net profit on component sales after-tax 240,000 (120,000) 120,000 (48,000) 72.000 40% 63 b) Cash flow from Argentina to Hermosa (US) 512,000 Cash flow loss on Hermosa's loss of exports Less US taxes on export losses c) Net cash flow reduction after-tax 40% (480,000) 192,000 (288,000) 70 71 d) Recapture of NWC in Argentina (no tax) 72 73 296,000 74 Total parent cash flow, after-tax (a+b+c+d) Initial investment Free cash flow to parent for discounting (2.000.000) S (2,000,000) S 296,000 Internal rate of return (IRR) Net present value (NPV) Comment Comment C D E F G H I J K L M N O Hermosa Components: Baseline Analysis Hermosa Beach Components, Inc., of California exports 24,000 sets of low-density light bulbs per year to Argentina under an import license that expires in five years. In Argentina the bulbs are sold for the Argentine peso equivalent of S60 per set. Direct manufacturing costs in the United States and shipping together amount to $40 per set. The market for this type of bulb in Argentina is stable, neither growing nor shrinking, and Hermosa holds the major portion of the market. 10 The Argentine government has invited Hermosa to open a manufacturing plant so imported bulbs can be replaced by local production. If Hermosa makes the investment, it will operate the plant for five years and then sell the building and equipment to Argentine investors at net book value at the time of sale plus the value of any net working capital. (Net working capital is the amount of current assets less any portion financed by local debt.) Hermosa will be allowed to repatriate all net income and depreciation funds to the United States each year. Hermosa traditionally evaluates all foreign investments in U.S. dollar terms. 16 Evaluate the proposed investment in Argentina by Hermosa Components (US). Hermosa's management wishes the baseline analysis to be performed in U.S. dollars (and implicitly also assumes the exchange rate remains fixed throughout the life of the project). Create a project viewpoint capital budget and a parent viewpoint capital budget. What do you conclude from your analysis? 18 19 20 21 22 23 24 25 26 27 Assumptions Light bulb export volume to Argentina, per year Sales price per set in Argentina Material costs per set in Argentina Material and shipping costs of imports per set Direct & indirect cost per set Depreciable investment buildings & equipment) Initial investment in net working capital Discount rate in Argentina Value 24,000 $ 60.00 20.00 $ 10.00 5.00 $ 1,000,000 $ 1,000,000 15.00% Growth 0.00% 0.00% 0.00% 0.00% 0.00% 28 B N 0 1 4 C D E F G H I J K L M Project Year Year 2013 2014 2015 2016 The capital budgeting analysis needs to be performed on both the Project Level (Project Viewpoint) and the Parent Level (Parent Viewpoint). O 2017 2012 31 32 33 Project Cash Flows in Argentina: Project Viewpoint Annual units sold (sets) Sales price in Argentina per set 24,000 60.00 36 S 37 38 39 40 41 42 Sales revenue Less direct manufacturing and shipping costs Less cost of US components @ $10/set Gross profit Less depreciation Pre-tax profit Less 40% Argentine taxes Net income Add back depreciation Annual project cash flow Return of net working capital Initial investment, total Free cash flow for discounting $ 1,440,000 (480,000) (240,000) 720,000 (200,000) 520,000 (208,000) 312,000 200.000 512,000 44 45 46 47 48 49 50 40% (2,000,000) S (2,000,000) $ 512,000 Internal rate of return (IRR) Net present value (NPV) C D E F G H I J K L The Parent Viewpoint needs to consider all incremental cash flow impacts including loss on export sales to Argentina (current practice). M N O 56 57 58 59 $ 60 Cash Flows to Hermosa in US: Parent Viewpoint Sales revenue on exports to Argentina Less direct and indirect costs on exported sets Profit on Hermosa's component sales Less US taxes on component profits @ 40% a) Net profit on component sales after-tax 240,000 (120,000) 120,000 (48,000) 72.000 40% 63 b) Cash flow from Argentina to Hermosa (US) 512,000 Cash flow loss on Hermosa's loss of exports Less US taxes on export losses c) Net cash flow reduction after-tax 40% (480,000) 192,000 (288,000) 70 71 d) Recapture of NWC in Argentina (no tax) 72 73 296,000 74 Total parent cash flow, after-tax (a+b+c+d) Initial investment Free cash flow to parent for discounting (2.000.000) S (2,000,000) S 296,000 Internal rate of return (IRR) Net present value (NPV) Comment Comment