Hermosa Beach Components $($U$.$S$.)$

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 $$60$ per set. Direct manufacturing costs in the United States and shipping together amount to $$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.

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.

Investment. Hermosa's anticipated cash outlay in U$.$S$.$ dollars in $2012$ would be as follows:

All investment outlays will be made in $2012,$ and all operating cash flows will occur at the end of years $2013$ through $2017.$

Depreciation and Investment Recovery. Building and equipment will be depreciated over five years on a straight$-$line basis. At the end of the fifth year, the $$1,000,000$ of net working capital may also be

repatriated to the United States, as may the remaining net book value of the plant.

Sales Price of Bulbs. Locally manufactured bulbs will be sold for the Argentine peso equivalent of $$60$ per set.

Operating Expenses per Set of Bulbs. Material purchases are as follows:

Transfer Prices. The $$10$ transfer price per set for raw material sold by the parent consists of $$5$ of direct and indirect costs incurred in the United States on their manufacture, creating $$5$ of pre$-$tax profit to

Hermosa Beach.

Taxes. The corporate income tax rate is $40\%$ in both Argentina and the United States $($combined federal and state$/$province$).$ There are no capital gains taxes on the future sale of the Argentine subsidiary, either

in Argentina or the United States.

$18\mathrm{.}7$ Hermosa Components: Baseline Analysis. Evaluate the proposed investment in Argentina by Hermosa Components $($U$.$S$.).$ 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?

$18\mathrm{.}8$ Hermosa Components: Revenue Growth Scenario. As a result of their analysis in Problem $18\mathrm{.}7,$ Hermosa wishes to explore the implications of being able to grow sales volume by $4\%$ per year.

Argentine inflation is expected to average $5\%$ per year, so sales price and material cost increases of $7\%$ and $6\%$ per year, respectively, are thought reasonable. Although material costs in Argentina are

expected to rise, U$.$S$.-$based costs are not expected to change over the five$-$year period. Evaluate this scenario for both the project and parent viewpoints. Is the project under this revenue growth scenario

acceptable?

$18\mathrm{.}9$ Hermosa Components: Revenue Growth and Sales Price Scenario. In addition to the assumptions employed in Problem $18\mathrm{.}8,$ Hermosa now wishes to evaluate the prospect of being able to sell

the Argentine subsidiary at the end of year $5$ at a multiple of the business's earnings in that year. Hermosa believes that a multiple of six is a conservative estimate of the market value of the firm at that time.

Evaluate the project and parent viewpoint capital budgets.