Fin 570: International Finance Dr. Greco, Summer 2009 Calvin C. Edward M. Vince T. Tiffany T. Rezene A. Calvin C. Edward M. Vince T. Tiffany T. Wiley International WI

WI Manufacturer of motors and componentsManufacturer of motors and components “Wiley Inc.” to “Wiley International”“Wiley Inc.” to “Wiley International” Best managers assigned to foreign divisionsBest managers assigned to foreign divisions –Regional managers propose to HQ –Made separately due to difficulties in risk differences About Wiley International

WI Richard Esposito’s new policy Uniform domestic and foreign decision making process Regional managers to provide project’s FCFs and NPV Apply U.S. hurdle rate of 9% to all international projects New policies speed up decision making –Consider non-quantifiable factors About Wiley International

WI Purpose: Purpose: Increase production capacity Finance a new manufacturing plantFinance a new manufacturing plant –Increase market share and profit margin Gain competitive advantageGain competitive advantage –Foreign firms who face trade barriers –Small domestic firms with a history of quality problems The Brazilian Proposal

WI Purpose of Request Quality of workforce and regulationsQuality of workforce and regulations Take advantage of incentive programs from Brazilian governmentTake advantage of incentive programs from Brazilian government Division requests – at R$2.8/US$1:Division requests – at R$2.8/US$1: The Brazilian Proposal

WI Financial Justification R$6m training expensed for taxesR$6m training expensed for taxes R$30m will be using 5-year straight-line depreciationR$30m will be using 5-year straight-line depreciation ProjectFinancing Project Financing Purchase equipment from Japan Financing 80% of project with 5-year loan denominated in Yen at 0.5% The Brazilian Proposal

Project’s IRR is calculated using CFs denominated in Real while U.S. hurdle rate is 9%Project’s IRR is calculated using CFs denominated in Real while U.S. hurdle rate is 9% 5.5% value (NY’s 6.0% - Japan’s 0.5%) is not an accurate measurement5.5% value (NY’s 6.0% - Japan’s 0.5%) is not an accurate measurement Degree of leverageDegree of leverage –1.5 to 1.0 is preferred –Project will result in ratio of 4.0 to 1.0 Esposito’s Concerns WI

WI Political Changes in government policy or the law Changes in government spendingEconomic Changes in inflation rate Exchange rate exposure Background of Brazil

WI ‘86: Plano Cruzado Jan ’89: Summer Plan Mar ’90: Plano Collor Jul ‘94: Plano Real Brazilian Inflation Rates

WI Fernando Henrique Cardoso Plano Real (Real Plan): Jul – Jan Created social emergency fund 2.Established Unidad Real 1:1 US dollar 3.Opened economy to foreign trade and investment Economic Stabilization Plans

Brazilian GDP WI

FHP Market Condition US Shipments increased 66% Light vehicle FHP motors 64% Other uses: – Appliance – HVAC – Computer – Industrial Source: The Freedonia Group

Market Condition U.S. Market Percentage of Imported FHP Growth 78% Mature Technology: Desire Low Cost Production WI Source: The Freedonia Group

WI Market Condition North America: Demand increased 29% Central/S. America: Demand increased 28% Source: The Freedonia Group

Growing South American Free Trade Mercosur : Argentina, Brazil, Paraguay, Uraguay, Venezuela Andean Community: Bolivia, Ecuador, Peru, Columbia Initiated Process to form a Single Trading Bloc in 1999 Market Condition WI

Manufacturing in Brazil and sell to: Brazilian domestic market Neighboring market Export to U.S. Takes advantage of exchange rate fluctuation Market Condition WI

WI Brazil is more attractive for Automotive FDI Potentially growing domestic automobile market –1:9 car per capita vs 1:2 car per capita in developed countries Technically advanced workforce –Skilled in aerospace and computer Brazilian Proposal

WI Brazil is more attractive relative to other South American countries Forecasted to be 6 th largest economy by 2015 Currently, largest economy in Latin America GDP per capita in 2001 is $6,500 – U.S. GDP per capita is $35,505 Brazilian Economic Data

Observations Brazil’s growth rate is above South America’s average Brazil’s growth rate is lower volatility Relative GDP Growth Rate

Observations Positive FDI Until 1999 – Year of devaluation – Short-term capital flight Negative Trade BalanceAssumption As the Real depreciated, FDI opportunities increased Balance of Payment Chart – Source:

Costs do not change overtime Inflation rate will be stable between 7-9% Automakers will continue to produce more vehicles Lower tariffs will still continue to existAssumptions WI

Basic Issues Hedging Risks LowLowHighHigh LowLow HighHigh Political & Economic Risks Standardizing IRRs CBRC Methodology WI Importance Urgency

Immediate Issues Hedging Risks LowLowHighHigh LowLow Importance Urgency HighHigh Financing Political & Economic Risks Accept or Decline the Project WI

WI Cause and Effect Diagram Political & Economic Stability Exchange Rate / IRR Determination Equipment Financing Industry Viability Project Decision Project Decision

IRR for foreign projects > 9% Finance with lowest interest rate   lowest foreign exchange risk Steady increasing cash flows Potential increase in market share Economy with increasing: –Growth rate –Domestic market –Technically advanced work force Decision Making Criteria WI

Alternative 1 Accept the proposal with the assumption that all calculations are correct. Accept the project assuming that it generates an IRR of 14.2% Accept financing 80% of project with 5-year loan denominated in Yen at 0.5% WI

Alternative 2 Reject the proposal. Reject the internal rate of return assumption WI

Alternative 3 Accept the proposal with revised calculations. Break Even Inflation Rate Apply inflation effect to IRR / NPV: Without Inflation Effect: 14.2% IRR & $ CF With Inflation Effect: 10.51% IRR & $16,761 CF Assumed Inflation Rate

Alternative 4 Seek another foreign supplier and financier. Assumptions: Inflation rates and interest rates will be around the current level for the next five years. PPP and IFE are at work in these markets WI

Financing Options WI

Financing Options WI

Conclusion IRR: IRR: 10.51% > 9% Financing: Financing: Real > US Dollar > Yen Choose Alternative #3: Accept the proposal with revised calculations Keep the current financing option (Japanese Yen at 0.5%) WI

Recommendations Look into future/forward contracts and see if it is cost effective: $800K difference between Yen and U.S. Dollar Look into other financing options in other countries. WI

WI Thank you

WI