n week 8, student teams will be expected to submit theInternational Capital Budgeting Analysispaper and presentation. This week, student teams should begin reading and reviewing the Imprimante case presented below with an eye towards applying in stages the APV model as outlined in the following equation. Please direct any questions to the instructor.

Imprimante S.A. Cross-Border Valuation and Parity Conditions

On June 18, 2018, a Monday morning, Martin Arnaud arrived at his office in Imprimante S.A. corporate headquarters in St. Ouen, France. The previous week, Arnaud had requested additional financial information about an investment proposal from Imprimante-Brazil, a wholly owned subsidiary that operated a manufacturing facility and a regional sales office in Salvador, Brazil. The information had arrived late Fridaytoo late for Arnaud to analyzeand was waiting for him Monday morning. As a financial analyst for a global manufacturer for printing and imaging equipment, Arnaud examined many cross-border projects, particularly since Imprimante had accelerated its move into emerging markets several years earlier.

The Brazilian investment proposal called for the purchase and installation of new automated machinery to recycle and remanufacture toner and printer cartridges. Cartridge recycling had become an important part of Imprimante's business in many markets and promised continued growth. Many office product retailers operated formal toner cartridge recycling programs, for both the environmental benefits of keeping materials out of landfills and demonstrated cost savings for their customers. Writing in a leading trade journal, one analyst predicted, "We are going to see more and more refined approaches to recycling and remanufacturing (cartridges) in the coming months and years...Both corporate and individual consumers are becoming habituated to it. They have simply come to expect recycling as an option, even for smaller cartridges at lower price points."

Imprimante's Salvador plant began its cartridge recycling program in 2015. The plant's recycling process consisted of a sequence of operations carried out almost entirely by hand, with the help of hand tools and a simple machine. The investment proposal called for replacing this process with new automated machinery from Austria that cost an estimated BRL3.5 million (approximately EUR770,000) fully installed. As described in the project summary, ImprimanteBrazil expected to realize substantial savings in labor and materials almost immediately. Because of the size of the automated machinery, Imprimante required a discounted cash flow analysis for all such investments in its newer foreign markets and a review by corporate headquarters in St. Ouen. Arnaud was assigned to perform an analysis of the investment proposal and make an "up or down" recommendation to his superior by Wednesday morning.

Imprimante S.A.

Imprimante S.A. is a global manufacturer of printers, copiers, fax machines, and other document production equipment. The company also provided consulting and document outsourcing services, with after-sales service contracts constituting about 18% of overall revenue. Company sales for 2018 were projected to be EUR3.35billion, down from 2017 due to changing technology in the printing sector. Operating profit was expected to be EUR61.2million in 2018, and the company projected a small net loss for the year. Exhibit 1 presents selected consolidated financial data for Imprimante.

Imprimante's low profitability was typical of the industry in 2018; all of its competitors were similarly affected by the technology shifts. One bright spot in the company's outlook, however, was its growth in several emerging markets, including the so-called BRIC economies of Brazil, Russia, India, and China. Imprimante had been a global firm for years but did not move aggressively into emerging markets until 2013-14. This was later than some of its competitors. On one hand, this meant Imprimante's market share lagged in some markets. On the other hand, Imprimante avoided some of its competitors' earlier mistakes and pioneering costs.

The company's international operations were conducted primarily through a large network of subsidiaries, which operated mostly medium-sized regional factories in which printers, copiers, and other products were manufactured to suit local tastes. Imprimante conducted business in 28 countries around the world, with operations consisting of manufacturing facilities, small research labs, as well as sales and marketing subsidiaries. In 2017, subsidiaries outside the European Union recorded about half of Imprimante's sales and generated slightly less than 40% of pretax income.

Imprimante competed in a relatively mature market, and its chief competitors were both established multinational companiessome of which had developed their consulting and other after-sales services businesses to a higher level than had Imprimanteas well as smaller players serving niche markets. While Imprimante marketed and sold its products across the full spectrum of industries, it had enjoyed particular success in the financial services, health care, and government sectors.

Operations in Salvador: Imprimante-Brazil

According to Imprimante's CEO Alain Belmont, "We were attracted to Brazil for the same reason we built operations in Brazil and other emerging markets. We wanted to diversify our operations and believed we needed to establish a strong presence in places besides Europe and the United States." He added: "Certainly there is risk (in these countries), but their economies are dynamic and Imprimante must be present. You can see our competitors feel the same way."

A key characteristic of Imprimante's printing and imaging products was their durability, which Imprimante's executives felt conveyed a competitive advantage in emerging economies where Imprimante positioned equipment as offering a lower total cost of ownership. In particular, the company's marketing material claimed a working life of 10 months longer than its closest competitor, with 30% lower service costs. CEO Belmont observed: "We demonstrate to our customers that we have a local presence and we are the lowest total-cost provider. This creates loyalty and solid market positions in Brazil and other of our newer markets."

The manufacturing facility in Salvador was located near a small research and design facility, also owned by Imprimante. While many product specifications for Imprimante's equipment were formulated at the corporate offices in St Ouen, France, it was customary for regional subsidiaries to conduct fine-tuning research and design activity to tailor the product more closely to local consumers' preferences. Thus, following an international strategic approach to its overseas operations, it was common for a popular printer or fax machine whose basic design was conceived in St. Ouen to be "localized" for size, color, weight, and/or range of features by local design staff. Most of the products produced in the Salvador plant were sold in Brazil and were distributed through large office-product retailers, department stores, as well as small specialty shops. Manufacturing inputs were sourced locally, and virtually all of the plant's employees were Brazilian citizens.

In the summer of 2018 gross output at Imprimante-Brazil was running at only about 80% of planned capacity. Nevertheless, plant records indicated that there was a sizable increase in demand for recycled printer and toner cartridges. Imprimante-Brazil's Programa de Reciclagem de Cartuchos (Cartridge Recycling Program) was started in 2015 to provide low-cost recycling services to all its distributors and customers. Under the terms of users' service contracts, when cartridges reached the end of their useful lives, they could be returned to the Imprimante facility in exchange for a significant discount on the purchase of a like number of newly recycled cartridges. With the discount, the current price Imprimante charges its customers is BRL80.00 per recycled cartridge. Imprimante pledged to recycle and remanufacture all returned toner and printer cartridges. In 2019, the company plans to launch a pilot program to recycle selected competitors' cartridges. Imprimante-Brazil also has voiced its support for political efforts to pass legislation that would mandate recycling of printing cartridges used by most Brazilian businesses and government offices. The Brazilian government offers financial assistance towards these efforts in the form of zero-interest financing of up to BRL1 million for five years for investments that directly improve the recycling capabilities of Brazilian firms. However, there are significant compliance and verification costs required by the Brazilian government on any such loans.

As the number of cartridges returned for recycling increased, Imprimante-Brazil management needed to hire and train more employees to carry out the hole-piercing, drilling, vacuuming, and toner/ink evacuation required to recycle cartridges. "It's taking more and more of my payroll to handle recycling," said Beatrice Ernesto, the Salvador plant manager. "We're happy to see the cartridges coming back in, but the extra volume will become a problem when other operations return to full capacity."

Cost Savings from the Proposed New Equipment

The new equipment could process the Salvador plant's projected volume using four employees rather than ten, resulting in savings of both direct labor and training costs. Under very favorable circumstances, only three workers would be required. It would also eliminate some human error, which currently resulted in cracked or damaged cartridges which had to be destroyed rather than reused. The new equipment would occupy significantly less space in Salvador's over-crowded plant; this space would be freed up for other productive uses. It would also require only minimal maintenance expenditures compared to the equipment it replaced, and no significant change in working capital. Exhibit 2 compares projected operating data for the existing recycling process and the proposed automated process, assuming future Brazilian inflation of 11% per year to 2022 and 7% per year thereafter.

The new equipment would have a useful life of 10 years and would be depreciated under the straight-line method for both tax and financial reporting purposes. Salvage value was likely to equal disposal costs at the end of the useful life. The manual equipment being replaced was very simple and, properly maintained, would last many more years. In June 2018 it had a book value and tax basis of BRL250,000 and three years of straight-line depreciation remaining. However, its market value was thought to be lower, at about BRL175,000. After considering Imprimante's consolidated tax position, Arnaud determined that his analysis would use Brazil's federal corporate tax rate of 34%.

Real GDP growth in Brazil was 0.5% in 2014the year in which Imprimante built its Salvador plant. By 2016, Brazil's real GDP growth had declined by 3.6% due to considerable political and economic uncertainty in the country. Other macroeconomic data in Brazil, including bond yields, bank lending rates, and the consumer price index (CPI) exhibited similar patterns in recent years. Exhibit 3 shows selected macroeconomic and financial market data for Brazil.

Arnaud had yet to decide whether to perform the discounted cash flow analysis in euros or reals, or indeed, whether NPV would be affected by the choice of currency. Imprimante's euro hurdle rate for such a project, if undertaken in France, would be 8%. However, borrowing costs in France and Brazil were clearly different: French banks' prime rate for euro loans was 4.99%, while the rate in Brazil on short-term real loans was about 8.10%. Longer-term real-denominated corporate bonds were yielding 9.21%, compared with long-term euro-denominated corporate issues at 4.75%. The spot exchange rate on June 18, 2018, was BRL4.36/EUR. Many analysts were on record predicting a real depreciation of the BRL against both the USD and the EUR over the next five years. For example, one international business publication noted: "(Brazil's) rising external financing requirement and the fading impact of global monetary stimulus policies can only increase pressure on Brazil's currency." The article went on to forecast a rise in the BRL/EUR rate to 5.22 by 2021 and upwards of 7.11 in 2023-28. Selected macroeconomic and financial market data for France are presented in Exhibit 4.

Exhibit 1 - Imprimante SA - Selected Consolidated Financial Data (millions of EUR, except as noted)2018*2017201620152014Sales3,345.33,561.83,576.93,078.93,050.3Operating income61.2189.2172.9163.5149.9Net income(0.7)85.761.288.285.7Total assets2,809.32,764.92,899.63,129.02,445.5Total debt660.6616.0613.0578.4504.2Equity782.6819.5829.7941.0865.1Capital expenditures87.6100.095.1240.9234.1Depreciation195.0209.4<214.0152.9155.0R&D expenditures17.520.019.048.246.8Earnings/share (euros)(0.0)1.00.71.11.0Dividend/share (euros)0.70.70.70.70.7Return on sales (%)0.0%2.4%1.7%2.9%2.8%Return on equity (%)-0.1%10.5%7.4%9.4%9.9%*Projected

Exhibit 2 - Comparison of Projected Operating Data for Different Recycling Processes (thousands of BRL, except as noted)Assumes 7% Inflation in Brazil

Brazil Corporate Tax Rate: 34%

France Corporate Tax Rate: 33.33%

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

Projected Operating Costs, Manual Process

Unit volume (000s)

496

546

600

660

660

660

660

660

660

660

Materials

564,816

664,788

782,456

920,951

985,417

1,054,396

1,128,204

1,207,178

1,291,681

1,382,099

Direct Labor

1,115,184

1,312,572

1,544,897

1,818,343

1,945,627

2,081,821

2,227,549

2,383,477

2,550,321

2,728,843

Overhead

1,680,000

1,797,600

1,923,432

2,058,072

2,202,137

2,356,287

2,521,227

2,697,713

2,886,553

3,088,611

Total

3,360,000

3,774,960

4,250,785

4,797,366

5,133,181

5,492,504

5,876,980

6,288,368

6,728,555

7,199,553

Materials/unit

1.1387

1.2176

1.3041

1.3954

1.4931

1.5976

1.7094

1.8291

1.9571

2.0941

Direct labor/unit

2.2484

2.4040

2.5748

2.7551

2.9479

3.1543

3.3751

3.6113

3.8641

4.1346

Projected Operating Costs, New Automatic Process

Unit volume (000s)

496

546

600

660

660

660

660

660

660

660

Materials

542,223

638,197

751,158

884,113

946,001

1,012,221

1,083,076

1,158,891

1,240,014

1,326,815

Direct Labor

524,136

616,909

726,101

854,621

914,445

978,456

1,046,948

1,120,234

1,198,651

1,282,556

Overhead

1,566,211

1,675,846

1,793,155

1,918,676

2,052,983

2,196,691

2,350,460

2,514,993

2,691,042

2,879,415

Total

2,632,570

2,930,952

3,270,414

3,657,410

3,913,429

4,187,368

4,480,484

4,794,118

5,129,707

5,488,786

Materials/unit

1.0932

1.1689

1.2519

1.3396

1.4333

1.5337

1.6410

1.7559

1.8788

2.0103

Direct labor/unit

1.0567

1.1299

1.2102

1.2949

1.3855

1.4825

1.5863

1.6973

1.8161

1.9433

Exhibit 3 - Selected Macroeconomic and Financial Market Data for BrazilYear

Consumer Price Inflation (%)

Real GDP Growth (%)

Year-end Spot Exchange Rate (BRL/EUR)

2010

5.91%

7.5%

2.22

2011

6.50%

4.0%

2.41

2012

5.84%

1.9%

2.70

2013

5.91%

3.0%

3.25

2014

6.41%

0.5%

3.22

2015

10.67%

-3.8%

4.30

2016

6.29%

-3.6%

3.43

2017

2.95%

0.9%

3.97

Source: Brazil Country Reports, EIU

Date

Short-term Bank Lending Rate

JPMorgan Brazil 7-10 Year Corporate Bonds

10-year Government Bonds

31-Mar-16

7.78%

8.20%

8.47%

30-Jun-16

7.68%

9.35%

9.06%

30-Sep-16

7.50%

8.22%

8.24%

31-Dec-16

7.60%

7.42%

7.42%

31-Mar-17

7.68%

7.50%

7.58%

30-Jun-17

7.82%

7.68%

7.19%

30-Sep-17

7.77%

7.86%

7.82%

31-Dec-17

8.00%

8.17%

8.08%

31-Mar-18

7.94%

7.42%

7.49%

30-Jun-18

8.10%

9.21%

9.12%

Sources: Bank of Brazil, Thomson Datastream, Global Financial Data

Exhibit 4 - Selected Macroeconomic and Financial Market Data for FranceYear

Consumer Price Inflation (%)

Real GDP Growth (%)

Year-end Spot Exchange Rate (BRL/EUR)

2010

1.7%

4.2%

2.22

2011

1.6%

2.1%

2.41

2012

1.9%

1.1%

2.70

2013

2.1%

0.5%

3.25

2014

2.3%

2.3%

3.22

2015

1.7%

1.9%

4.30

2016

1.7%

2.4%

3.43

2017

1.5%

2.3%

3.97

Source: France Country Reports, EIU

Date

Short-term Bank Lending Rate

JPMorgan France 7-10 Year Corporate Bonds

10-year Government Bonds

31-Mar-16

3.08%

3.73%

3.79%

30-Jun-16

3.27%

4.03%

4.08%

30-Sep-16

3.63%

3.69%

3.72%

31-Dec-16

4.07%

3.96%

3.98%

31-Mar-17

4.42%

4.08%

4.11%

30-Jun-17

4.69%

4.60%

4.62%

30-Sep-17

4.91%

4.36%

4.41%

31-Dec-17

5.13%

4.34%

4.42%

31-Mar-18

4.81%

4.00%

4.11%

30-Jun-18

4.99%

4.75%

4.81%

Sources: Thomson Datastream, CEIC, Global Financial Data