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Hermosa Beach Components

Hermosa Beach Components exports light bulbs to Argentina and holds a major share of that market. The Argentine government has invited Hermosa to open a local manufacturing plant to replace imports. If Hermosa invests $2 million to build the plant, it will operate for 5 years, sell the assets, and repatriate all profits annually in US dollars. Hermosa must evaluate if this investment is worthwhile from the perspectives of the project and parent company in US dollar terms using a 15% discount rate.

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Minh Nhut
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41 views2 pages

Hermosa Beach Components

Hermosa Beach Components exports light bulbs to Argentina and holds a major share of that market. The Argentine government has invited Hermosa to open a local manufacturing plant to replace imports. If Hermosa invests $2 million to build the plant, it will operate for 5 years, sell the assets, and repatriate all profits annually in US dollars. Hermosa must evaluate if this investment is worthwhile from the perspectives of the project and parent company in US dollar terms using a 15% discount rate.

Uploaded by

Minh Nhut
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Hermosa Beach Components, Inc.

, of California exports 24,000 sets of low-density light bulbs per year


to Argentina under an import license that expires in five years. In Argentina, the bulbs are sold
for the Argentine peso equivalent of $60 per set. Direct manufacturing costs in the United States and
shipping together amount to $40 per set. The market for this type of bulb in Argentina is stable, neither
growing nor shrinking, and Hermosa holds the major portion of the market.
The Argentine government has invited Hermosa to open a manufacturing plant so imported bulbs can
be replaced by local production. If Hermosa makes the investment, it will operate the plant for five years
and then sell the building and equipment to Argentine investors at net book value at the time of sale
plus the value of any net working capital. (Net working capital is the amount of current assets less any
portion financed by local debt.) Hermosa will be allowed to repatriate all net income and
depreciation funds to the United States each year. Hermosa traditionally evaluates all foreign
investments in U.S. dollar terms
Investment: Hermosa’s anticipated cash outlay in U.S. dollars in 2012 would be as follows:
Building and equipment $1,000,000
Net working capital 1,000,000
Total investment $2,000,000
All investment outlays will be made in 2012, and all operating cash flows will occur at the end of years
2013 through 2017.
Depreciation Building and equipment will be depreciated over five years on a straight-line basis. At the
end of the fifth year, the $1,000,000 of net working capital may also be repatriated to the United States,
as may the remaining net book value of the plant.
Sales price of bulbs. Locally manufactured bulbs will be sold for the Argentine peso equivalent of $60
per set.
Operating expenses per set of bulbs. Material purchases are as follows:
Materials purchased in Argentina (U.S. dollar equivalent)$20 per set
Materials imported from Hermosa Beach-USA $10 per set
Total variable costs $30 per set
Transfer prices. The $10 transfer price per set for raw material sold by the parent consists of $5 of
direct and indirect costs incurred in the United States on their manufacture, creating $5 of pre-tax profit
to Hermosa Beach.
Taxes. The corporate income tax rate is 40% in both Argentina and the United States (combined federal
and state/province). There are no capital gains taxes on the future sale of the Argentine subsidiary,
either in Argentina or the United States.
Discount rate. Hermosa Components uses a 15% discount rate to evaluate all domestic and foreign
projects.
Baseline Analysis. Evaluate the proposed investment in Argentina by Hermosa Components (U.S.).
Hermosa’s management wishes the baseline analysis to be performed in U.S. dollars (and implicitly
also assumes the exchange rate remains fixed throughout the life of the project). Create a project
viewpoint capital budget and a parent viewpoint capital budget. What do you conclude from your
analysis?

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