Santa Clara Electronics, Inc. of California (SCE) currently exports 30,000 electric switches per year to Argentina under an important agreement that expires in five years. In Argentina, the imported switches are currently sold for the peso equivalent of $50 per set. SCEs costs, including shipping, are $35 per set, and its current pre-tax profit is $15 per set. The market for this type of switch in Argentina is stable and SCE holds a major portion of the market.

The Argentine government has invited SCE to open an assembly plant so that imported switches can be replaced by local production. If SCE makes the investment, it will operate the plant for 5 years and then sell the building and equipment to Czech investors for net book value at the time of the sale. SCE will be allowed to repatriate all net income and depreciation to the U.S. at the end of each year. SCE traditionally evaluates all foreign investments in U.S. dollar terms.

SCEs anticipated outlay in 2018, expressed in USD and sufficient for the full 5 years, would be:

Building and equipment $2,000,000

Working capital $1,000,000

Total outlay $3,000,000

All investment outlays will be made in 2018, and all operating cash flows will occur at the end of years 2019 through 2023.

Building and equipment will be depreciated over five years on a straight-line basis to a $500,000 salvage value. At the end of the 5th year, the $1,000,000 of net working capital may be repatriated to the U.S., as may the remaining net book value (salvage value) of the plant.

The Argentine peso (AP) is currently at parity (USD1=AP1) and is expected to remain at this level for the next 5 years.

Locally manufactured switches will be sold at AP50 each. Sales volume will remain at 30,000 switches per year for the next 5 years.

Variable operating expenses are expected to be as follows:

Materials purchased locally in Argentina AP15 per set

Material imported from the US parent AP15 per set

Total variable costs AP30 per set

The AP15 purchase price for components sold by SCE to its Argentine subsidiary consists of AP9 for direct costs incurred in the US and AP6 for pretax contribution margin to SCE. These peso costs (and profits) are expected to remain constant. Other operating costs include AP50,000 in annual fixed operating costs by the Argentine subsidiary.

Both Argentina and the U.S. have a corporate income tax rate of 40 percent.

The Argentine government will assist SCEs local financing by providing a subsidized loan of 3 million pesos. The loan will be a 5-year amortizing loan (with annual payments) bearing an interest rate of 6 percent. Without the loan, SCEs normal borrowing rate would be 12 percent.

Upstate uses a 15% discount rate to evaluate all domestic and foreign projects.

a)Estimate the value of the project as a stand-alone investment. (From the projects perspective). b)Estimate the value of the intra-company sales to the parent. c)Estimate the value of the concessionary loan to the parent. d)Estimate the value of the projects cash accruing to the parent.