Case Report “3P Turbo—Cross Border Investment in Brazil” Part 1.

ZZBU8703 International Finance

Instructions
Read the case assigned “3P Turbo—Cross Border Investment in Brazil” by Booth and Nelson and answer the
following questions individually.

This case gives you the opportunity to use spreadsheets for cross-border investment analysis to determine if
the investment creates value. In particular, in Part 1, we will calculate the value of a low interest loan, which
will be added to NPV analyses that should be done in Part 2.

The goal of Part 1 of the case report is to understand the case and think about how to approach the problems
presented in the case. In Part 2, you are required to write up an executive memo suggesting the solution to
the decision maker in the case in a professional way, utilizing some of the analyses from Part 1. The answers
to Part 1 do not have to be in essay style, but your analysis and feedback from Part 1 would be helpful to build
the final report due after Week 10. Some questions are in a multiple-choice format with correct answers, but
the rest of them are based on quantitative analyses and short answers.

PLEASE ANSER THE QUESTIONS ONLY BASED ON THE INFORMATION IN THE CASE STUDY. In other
words, you don’t have to search or bring outside information to answer the questions.

Please submit your answers in Moodle.

Part 1 Questions
Understanding the case

1. Which of the following is not correct regarding the situation Jason Starks, the founder of 3P Turbo, faced in
2016? (1 point)

A. Jason was contemplating setting up a facility to manufacture automobile turbochargers in Brazil.

B. At that time, Brazil was experiencing huge political turmoil and was hit with the worst recession in
two decades.

C. The recession in Brazil in 2016 was exacerbated by high commodity prices and the economic boom of
the Chinese economy.

D. Even with the political and economic turmoil in 2016, the advantage of investing now is to take
advantage of weak Brazilian Real and low competition in Brazil now.

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 2. Which of the following is not correct regarding the risks and opportunities in the Brazilian automobile
industry? (1 point)

A. Skilled labor is available especially in certain locations such as Sao Paulo and the cost of doing
business is very low. In particular, Brazilian government is accommodating doing business by
applying efficient tax systems and unrestricted labor laws.

B. As a member country of the Mercado Comum do Sul, 3P Turbo could enjoy trading at zero tariffs
within most of the South American markets if it manufactured products in Brazil.

C. The Inovar Auto Incentives would provide reduction in taxes, but it is uncertain to last after Rouseff’s
regime.

D. Brazil is one of the largest producers of cars and trucks in Latin America. 3P Turbo would expect
substantial demand for turbochargers.

3. Why would 3P Turbo consider investing in Brazil? For 3P Turbo, what are the advantages and
disadvantages of having a manufacturing facility in Brazil? (2 points)

(Organize your answer into three bullet points each for advantages and disadvantages)

Advantages:

• _________________________

• _________________________

• _________________________

Disadvantages:

• _________________________

• _________________________

• _________________________

4. Based on Exhibit 2, what happened to the value of Brazilian Real in the past five years (2011-2016)? If the
trend of the foreign exchange rate (R$/US$) is expected to continue, how would the foreign exchange rate
affect 3P Turbo’s decision? (2 points)

(300 words)

__________________________________________

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5. Given the current spot rate (R$/US$) and other macroeconomic factors provided in the case, what would be
the expected future exchange rates for next 5 years? Please fill out the numbers below assuming the parity
conditions hold. (2 points)

(Hint: You can find relevant information in page 6. Enter the answer at least up to two decimal points.)

Spot rate (R$/US$) 2016: ________________

Calculating the value of a low-cost financing

The German vendor had offered to finance R$90 million of the equipment cost (90% of the overall cost) at a
low interest rate of 2%. The seller financing agreement required 3P Turbo to completely pay off the loan, both
principal and interest, over five equal installments.

Let’s calculate the present value of the saving from this low-cost financing in Real in Part 1. In Part 2, we are
going to project expected future cash flows in Real for 3P Turbo’s operation and add the value of a low-cost
financing to the NPV analysis.

Please use the excel spreadsheet provided as a guideline to answer your question. To help your understanding,
we also provide some hints in the excel spreadsheet as well—click the comment in each cell.

6. From the case, please find relevant information below: each answer will be entered in the excel spreadsheet
(2 points)

A. Cost of equipment (Euro, ‘000s) – Cell C5

B. Cost of equipment (R$, ‘000s) – Cell C6

C. Spot Exchange Rate (R$/Euro) – Cell C7

D. Value of Loan (90% of Cost, Euro, ‘000s) – Cell C8

E. Loan Rate from German Bank – Cell H5 %

F. Loan Rate from German Vendor – Cell H6 %

G. Tax rate – Cell H9 %

7. What is the annual payment in Euro if 3P Turbo takes a loan from German Bank at 6% of interest rate? The
answer will be entered in cells D15, E15, F15, G15, H15. (2 points)

(Hint: Please use the annuity formula or excel function “PMT(rate,nper,pv,fv,type).” Pv would be the value of
the loan and fv is set to zero.)

Answer: _______________ EUR

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8. Since interest on both loans (from German vendor and from German Bank) is tax deductible, the savings
from cheap financing have to be calculated on an after-tax basis. To calculate the after-tax loan payment, you
need to split the annual loan payment into interest payment (i.e., remaining principal*interest rate) and
principal parts, calculate after-tax interest payment (i.e., (1-tax rate)*before-tax interest payment) and add
after-tax interest payment and principal again.

Assume that the inflation in Germany is expected to be 5% and future exchange rates would follow the parity
condition. Assume that the company does not take any hedging positions for foreign exchange risks.

What is the amount of saving in financing cost every year 2017-2021 in Real if 3P Turbo received a loan from
German Vendor compared to the 6% interest rate loan from German Bank? What is the present value of
savings in Real? (5 points)

(Tip: Please provide the answers below and upload your work in the Excel spreadsheet on the tab, “Table 1 No
hedge.”)

Saving in financing cost (R$ ‘000, cells D30-H30)

2017: ________________

2018: ________________

2019: ________________

2020: ________________

2021: ________________

Present value of savings (R$ ‘000, cell C32): __________________

9. Suppose that 3P Turbo can enter into a currency swap agreement at 4.2 $R/Euro to lock in the value of loan
payment in Euro.

What is the amount of saving in financing cost every year 2017-2021 in Real if 3P Turbo received a loan from
German Vendor compared to the 6% interest rate loan from German Bank? What is the present value of
savings in Real? (5 points)

(Tip: Please provide the answers below and upload your work in the Excel spreadsheet on the tab, “Table 2
Hedging.”)

Saving in financing cost (R$ ‘000)

2017: ________________

2018: ________________

2019: ________________

2020: ________________

2021: ________________

Present value of savings (R$ ‘000, cell C32): __________________

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10. Would you recommend 3P Turbo to hedge the foreign exchange risks? Explain why. (2 points)

(300 words)