THE CASE OF ALPEK'S CO-INVESTMENT IN RUSSIA. UPDATED January 5, 2021 INTRODUCTION Last September 27, 2013 appeared in the Business section, of the newspaper El Norte, which is published in Monterrey, the article named: "Alpek co-invests in plant in Russia". The author is Moiss Ramrez. Additionally, last September 4, 2018, the same author published, in the same source, an article entitled: "Evala Alpek entrar a Europa." The following mini-case that I will present to you is based on both articles, however, it is necessary to clarify that only part of the information is taken from both articles, and another significant part of the information has had to be invented, since the publications do not present all the information necessary to evaluate this investment project, according to the procedures illustrated in chapter 6 of the textbook. It is worth mentioning that the content of chapter 6 of the textbook presents the procedures and points to consider in order to correctly determine the cash flows used to evaluate any investment project. Context TRANSCRIPT OF THE SEPTEMBER 27, 2013 ARTICLE Alpek, the petrochemical division of the Alfa business conglomerate, is looking to make its first leap outside the Americas after signing an agreement with Russia's United Petrochemical Company (UPC) to install an integrated PTA and PET plant there, via a shared investment estimated at more than $500 million. Alpek is the leading private producer of PTA and PET, packaging materials for beverages, food and personal care, in Latin America. In a press release, the company explained that the entire project is being carried out with its subsidiary Petrotemex and that the plant will have an annual production capacity of 600,000 tons of PTA and 600,000 tons of PET. He added that Alpek and United Petrochemical Company (UPC) also agreed to invest 10 million dollars each in the preparation of a detailed business plan that will determine the feasibility of building the plant. Alpek sources estimated that, given the magnitude of the plant, the overall investment in the plant will be more than 500 million dollars and that it will take about 12 months to conclude the business plan and for the boards of directors of both companies to approve the plan. It is still premature to say how much of this investment we (Alpek) will finance with capital and how much with debt," added a source from the company. Once both phases are concluded, the sources added, the construction of the plant would begin at the end of 2014 or early 2015 and in 2017 it would start operating to serve only the Russian market. The sources explained that the interest in co-investing in a plant for the Russian market derives from the strong development of PET per capita in that country and the market potential it offers. Another attraction, they added, is the important operational synergies offered by Sistema JSFC, controller of United Petrochemical Company (UPC), since it owns Bashneft, one of the largest oil companies in Russia, which will supply paraxylene, the basic material for producing PTA, to the new plant. The Russian operation will increase Alpek's global PET capacity by 12.5 percent. (End of article transcription). NECESSARY INFORMATION, AND ASSUMPTIONS, TO EVALUATE THE INVESTMENT PROJECT, UPDATED ON JANUARY 5, 2021. 1. The "revised" total investment, in the plant in Russia, has been updated to US$800 million. 2. We assume, and only for purposes of use in the problem, that the investment to be made by Alpek is 50% of the total; that is, the amount of the investment is 400 million dollars: [800 x .50]. Consider that this investment is made in year 0, which is the year 2021. 3. Similarly, we assume that 50 % of the production corresponds to Alpek; and the remaining 50 % to UPC. The total capacity of the plant has been updated to 625,000 tons per year of PTA; and another 625,000 tons of PET. 4. Therefore, Alpek's total production capacity will be 312,500 tons per year of PTA; and another 312,500 tons per year of PET. 5. The plant will be ready to start production in early 2022. 6. We will consider that, being a new plant, it will not start working at 100% of its capacity, but that production and sales will occur as follows: a) In 2022 production will be at 70% of installed capacity; b) In 2023 production will be 82 % of installed capacity; c) In 2024 production will be at 82 % of installed capacity. c) In 2024 production will be at 90% of installed capacity; and d) In 2025 it will reach the full capacity level of 100%. 7. At the end of 7 years, the plant will have an estimated market value of US$150 million, and since Alpek will supply 50% of the investment, it has been agreed with UPC that 50% of such resources will correspond to Alpek. 8. It has been estimated that the sale price of both PTA and PET will increase at an annual rate of 2.8% during the life of the project. Now, the sales price of PTA, in 2017, was $2,100 dollars per ton; while the estimated sales price of PET, also in 2017, was $2,150 dollars per ton. 9. The most important element of the production cost, both for PTA and PET, is paraxylene; however, it is not the only production cost, additionally, it has been considered that the cost of labor will be $150 dollars per ton; and $185 dollars for electricity and other indirect manufacturing expenses; Thus, it is known that in 2017, the cost per ton of paraxylene was $1,110 dollars, to which should be added the $150 of direct labor, and the $185 of electricity, to give a total, in 2017, of $1,445 dollars of production cost (already including all the above costs). Assume that these costs maintain since the end of 2017 an annual increase of 7.6 % . 10. The corporate tax rate that corresponds to this project is 35 %. 11. Regarding investment in net working capital, and just like any other manufacturing company, Alpek knows that it must make investments in working capital. It will purchase raw materials prior to production and sale; that is, it will invest in inventory. It will hold cash as a buffer against unforeseen expenses. In addition, its credit sales will not generate cash until payment is made at a later date. Alpek's management determines that an initial (year 0; year zero is 2021) investment in working capital of $195 million is required. Thereafter, net working capital at the end of each year will be equal to 10% of sales for that year. In the last year of the project (which will be after 7 years) the net working capital will be reduced to zero as the project reaches completion. 12. For purposes of project evaluation, we assume that all cash flows occur at the end of the year. 13. The fixed asset (plant) depreciation method will be performed according to the "modified accelerated cost recovery system", i.e., the system known as MACRS; and table 6.3 of the textbook specifies the depreciation percentages for each year, depending on the type of recovery period. According to point # 7 above, the life of this project is 7 years. 14. Calculate both the net present value of this Alpek investment project, as well as its IRR. Consider that the required discount rate is 18.5%. Have you detected any problem(s) in calculating the IRR? Please explain