Question

1. Santa Clara Electronics, Inc. of California currently exports 1,000,000 electric switches per year to the Argentina under an import agreement that expires in five years. In the Argentina, the imported switches are currently sold for peso equivalent of $75 per set. Santa Clara’s costs, including shipping, are $50 per set, and its current pre-tax profit is $25 per set. Similar costs and prices would occur in Argentine production. The market for this type of switch in the Argentina is stable (neither growing nor shrinking, and Santa Clara holds the major portion of this market.

   The Argentine government has invited Santa Clara to open an assembly plant so that imported switches can be replaced by local production. If Santa Clara makes the investment, it will operate the plant for 5 years and then sell the building and equipment to Argentine investors for $5,000,000. Santa Clara will be allowed to repatriate all net income and depreciation to the US at the end of each year. Santa Clara traditionally evaluates all foreign investments in U.S. dollar terms.  

   Investment:   Santa Clara’s anticipated outlay in 2020, expressed in US dollars and sufficient for the full five years, would be:

                         Building and Equipment                          $40,000,000

                         Working Capital                                            $10,000,000

                         Total Outlay                                              $50,000,000

              All investment outlays will be made in 2020, and all operating cash flows will occur at the end of years 2021 through 2025.

   Depreciation:           Building and equipment will be depreciated over five years on a straight-line basis to a $5,000,000 salvage value. At the end of the fifth year, the $10,000,000 of net working capital may be repatriated to the United States, as may the remaining net book value (salvage value) of the plant.

   Exchange Rates:           The Argentine peso (Ps) is currently at parity (US$1 = APs1) and is expected to remain at this level for the next five years.

   Sales: Locally manufactured switches will be sold APs75 each. Sales volume will remain 1,000,000 switches per year for the next five years.  

   Operating Expenses (current peso costs):

              Materials purchased in Argentina                 Aps30 per set

              Material imported from US parent               Aps20 per set

              Total variable costs                                    Aps50 per set

   The Aps20 purchase price for components sold by Santa Clara to its Argentine subsidiary consists of Aps15 of direct costs incurred in the United States and Aps5 of pretax contribution margin to Santa Clara. These peso costs (and profits) are expected to remain constant. Other operating costs include APs 5,000,000 in annual fixed operating costs by the Argentine subsidiary.

   Taxes:           Both the Argentina and the United States have a corporate income tax rate of 40 percent.

   Concessionary Loan: The Argentine government will assist Santa Clara’s local financing by provided a subsidized loan of 50 million peso loan. The loan will be a five-year amortizing loan (with annual payments) bearing an interest rate of 5 percent. Without the loan, Santa Clara’s normal borrowing rate would be 10 percent.

   Cost of Capital:           Upstate uses a 15 percent discount rate to evaluate all domestic and foreign projects.

              Estimate the value of the lost exports to the parent.

   		$50,282,330
   		$68,432,421
   		$56,721,196
   		$64,027,351
   		$62,782,540

Answer 1

Solution :

Pre-tax profit per set = 25, so total pre-tax profit per annum = 25*number of switches sold per year

= 25*1,000,000

= 25,000,000

After-tax profit p.a. = 25,000,000*(1-Tax rate)

= 25,000,000*(1-40%)

= 15,000,000

Loss of exports value is present value (PV) of after-tax profit for 5 years at 15% discount rate:

PMT = -15,000,000; N = 5; rate = 15%, solve for PV.

PV = 50,282,326

(Option (A) 50,282,330 is the closest option)

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