13. DFI to Achieve Economies of Scale Bear Co. and Viking, Inc., are automobile manufacturers that desire to benefit from economies of scale. Bear Co. has decided to establish distributorship subsidiaries in various countries, while Viking, Inc., has decided to establish manufacturing subsidiaries in various countries. Which firm is more likely to benefit from economies of scale? 13a. DFI Strategy Bronco Corp. has decided to establish a subsidiary in Taiwan that will produce stereos and sell them there. It expects that its cost of producing these stereos will be one-third the cost of producing them in the United States. Assuming that its production cost estimates are accurate, is Bronco’s strategy sensible? Explain. 14. Impact of Financing on NPV Explain how the financing decision can influence the sensitivity of the net present value to exchange rate forecasts. 14.2 PepsiCo’s Project in Brazil PepsiCo recently decided to invest more than $300 million for expansion in Brazil. Brazil offers considerable potential because it has 150 million people and their demand for soft drinks is increasing. However, the soft drink consumption is still only about one-fifth of the soft drink consumption in the United States. PepsiCo’s initial outlay was used to purchase three production plants and a distribution network of almost 1,000 trucks to distribute its products to retail stores in Brazil. The expansion in Brazil was expected to make PepsiCo’s products more accessible to Brazilian consumers. a. Given that PepsiCo’s investment in Brazil was entirely in dollars, describe its exposure to exchange rate risk resulting from the project. Explain how the size of the parent’s initial investment and the exchange rate risk would have been affected if PepsiCo had financed much of the investment with loans from banks in Brazil. b. Describe the factors that PepsiCo likely considered when estimating the future cash flows of the project in Brazil. c. What factors did PepsiCo likely consider in deriving its required rate of return on the project in Brazil? d. Describe the uncertainty that surrounds the estimate of future cash flows from the perspective of the U.S. parent. e. PepsiCo’s parent was responsible for assessing the expansion in Brazil. Yet, PepsiCo already had some existing operations in Brazil. When capital budgeting analysis was used to determine the feasibility of this project, should the project have been assessed from a Brazilian perspective or a U.S. perspective? Explain. 15. Uncertainty Surrounding a Foreign Target Refer to question 7. What are some of the key sources of uncertainty in Blore’s valuation of the target? Identify two reasons why the expected cash flows from an Asian subsidiary of a U.S.-based MNC would be lower if Asia experienced a new crisis. 15a. Decision to Sell a Business Kentucky Co. has an existing business in Italy that it is trying to sell. It receives one offer today from Rome Co. for $20 million (after capital gains taxes are paid). Alternatively, Venice Co. wants to buy the business but will not have the funds to make the acquisition until 2 years from now. It is meeting with Kentucky Co. today to negotiate the acquisition price that it will pay for Kentucky in 2 years. If Kentucky Co. retains the business for the next 2 years, it expects that the business will generate 6 million euros per year in cash flows (after taxes are paid) at the end of each of the next 2 years, which would be remitted to the United States. The euro is presently $ 1.20, and that rate can be used as a forecast of future spot rates. Kentucky would only retain the business if it can earn a rate of return of at least 18 percent by keeping the firm for the next 2 years rather than selling it to Rome Co. now. Determine the minimum price in dollars at which Kentucky should be willing to sell its business (after accounting for capital gain taxes paid) to Venice Co. in order to satisfy its required rate of return. 16. Incorporating Country Risk in Capital Budgeting How could a country risk assessment be used to adjust a project’s required rate of return? How could such an assessment be used instead to adjust a project’s estimated cash flows? 16a. Country Risk Ratings Assauer, Inc., would like to assess the country risk of Glovanskia. Assauer has identified various political and financial risk factors, as shown below. Assauer has assigned an overall rating of 80 percent to political risk factors and of 20 percent to financial risk factors. Assauer is not willing to consider Glovanskia for investment if the country risk rating is below 4.0. Should Assauer consider Glovanskia for investment? POLITICAL RISK FACTOR ASSIGNED RATING ASSIGNED WEIGHT Blockage of fund transfers 5 40% Bureaucracy 3 60% FINANCIAL RISK FACTOR ASSIGNED RATING ASSIGNED WEIGHT Interest rate 1 10% Inflation 4 20% Exchange rate 5 30% Competition 4 20% Growth 5 20%
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