As the newly hired financial analyst for Rodgers International

As the newly hired
financial analyst for Rodgers International, you are charged with evaluating a
possible investment by the firm in Bolivia. It is the end of 2014 (year 0) and
an idle Bolivian facility is available to be purchased at a price of 25,000,000
Bolivian Boliviano (BOB).
Rodgers is currently exporting twitters to Bolivia and
expects to export 15,000 units next year (2015, or Year 1) at a price of BOB
400 per unit with future demand for exported twitters expected to grow at 5
percent per year thereafter; besides the expected growth in the number of
twitters exporter, future prices of exported
twitters are expected to increase by 2 percent per year. Export sales yield the
firm an after-tax profit margin of 14 percent. However, buying the
Bolivian facility would eliminate these export sales and replace them with new
local sales expected to be 30,000 units in 2015, maintaining the same BOB 400
sales price. Future Bolivian demand for locally-produced twitters is expected
to grow at 7 percent per year with future price increases of
domestically-produced twitters expected to average 8 percent per year in
Bolivian boliviano terms.
The variable cost of producing twitters in Bolivia is
forecasted to be BOB 200 per unit in the first year of operations (2015) with
such costs growing at an average rate of 3 percent per year thereafter. Fixed
costs, other than depreciation, are expected to be BOB 2,000,000 in 2015, with
future costs growing at the general level of inflation of 8 percent per year
thereafter. Depreciation of the facility will follow Bolivian guidelines of 5
years, straight-line of the total BOB 25,000,000 investment. (Disregard the
expected salvage value when calculating the annual depreciation expense of the
facility).
The Bolivian and U.S. tax rates are each 34 percent.
Rodgers expects to annually remit 100 percent of the cash flows generated by
the project back to the parent. Although uncertain, the firm believes that it
will be able to resell the company to local investors for an after-tax amount
of BOB 15,000,000 after five years of operations (i.e., the expected salvage
value).
The current exchange rate is BOB/USD 6.3300 with future
exchange rate changes expected to follow purchasing power parity; the inflation
rate is expected to remain at 8 percent per year over the next five years in
Bolivia and 5 percent per year in the U.S. In evaluating foreign investments
Rogers typically uses a discount rate of 15 percent. However, because of
various assurances the company has received from the Bolivian government and
the Inter-American Development Bank, a discount rate of 12 percent was deemed
to be more appropriate.
1. Should Rodgers make this investment, and explain
why or why not?
2. Assume the same facts as above except that
Rodgers is unsure about the salvage value of the investment. How much would
Rodgers need to receive from selling the operations at the end of year five to
make this a viable project? That is, what is the minimum salvage value (in BOB
terms)? How could this information be useful in the decision to invest or not
to invest?
3. Assume the same situation as in part 1,
except that now there is an Argentine competitor that is planning to invest in
Bolivia, but only if Rodgers chooses not to make the investment. If the
competitor makes the investment, Rodgers is expected to lose its entire export
market in South America. All of the original information from part 1 should be
assumed to remain the same. How does this new assumption affect your analysis?
Would you recommend making the investment under these circumstances?

4. Assume the same situation as in part 3.
Despite the current inflation rate differential between the two countries the
corporate treasurer at Rodgers has made a forecast in which she expects the
Bolivian boliviano to depreciate against the U.S. dollar by 5 percent per year
over the next five years. How does this new assumption affect your analysis? Would
you recommend making the investment under these circumstances?

5. Assume the same situation as in part 3
except that the Bolivian government is politely
suggesting that Rodgers should invest the cash flows that it generates each
year from the project into a Bolivian government fund yielding an after-tax
return of 10 percent per year. After five years, the full amount of the funds
would be available for withdrawal by Rodgers, along with the salvage value
proceeds from the project itself. How would this information affect your
analysis of the project from both a quantitative and qualitative basis?
Would you recommend making the investment under these circumstances?