Ipanema Beach, a Brazilian Company, is considering establishing an operation in the United States to assemble and distributes Ipanema hats. The initial investment is estimated to be R$100,000,000 (Brazilian Reals) which is equivalent to US$23,000,000 at the current exchange rate. Given the current corporate income tax rate in the United States, Ipanema Beach created an estimate of the total after-tax annual cash flow in each of the three years of the investments life (see table below). However, the U.S. national legislature is considering a reduction in the corporate income tax rate that would go into effect in the second year of the investment’s life, and would result in the following total annual cash flows presented below. Year Estimated CF without tax reduction Estimated CF with tax reduction 1 10500000 10500000 2 1.25E7 1.45E7 3 1.55E7 1.85E7 * If you are not familiar with the notation, 1E6 is 1 time 10 to the power of 6. Essentially how many zeros need to be added. Ipanema Beach estimates the probability of the tax rate reduction occurring at 50%. Ipanema Beach uses a discount rate of 10% evaluating potential capital investments. Present value factors are as follows: Year PV Factor 1 0.9091 2 0.8264 3 0.7513 The U.S. operation will distribute 100% of its after-tax annual cash flow to Ipanema Beach as a dividend at the end of each year. The terminal value of the investment at the end of three years is estimated to be US$25,000,000. Neither the dividends nor the terminal value received from the U.S. investment will be subject to a Brazilian income tax. Exchange rate between the Brazilian Real and USD are forecasted as follows: Year Reals to USD 1 5.4 2 5.3 3 5.5 Questions: 1. Determine the expected net present value of the potential US investment from a parent company perspective. 2. If, after receiving new information, the company expects the probability of the tax rate reduction to be higher than originally expected, what would happen to the NPV? Would it increase or decrease and why?
Ipanema Beach, a Brazilian Company, is considering establishing an operation in the United States to assemble and distributes Ipanema hats. The initial investment is estimated to be R$100,000,000 (Brazilian Reals) which is equivalent to US$23,000,000 at the current exchange rate.
Given the current corporate income tax rate in the United States, Ipanema Beach created an estimate of the total after-tax annual cash flow in each of the three years of the investments life (see table below).
However, the U.S. national legislature is considering a reduction in the corporate income tax rate that would go into effect in the second year of the investment’s life, and would result in the following total annual cash flows presented below.
| Year | Estimated CF without tax reduction | Estimated CF with tax reduction |
|---|---|---|
| 1 | 10500000 | 10500000 |
| 2 | 1.25E7 | 1.45E7 |
| 3 | 1.55E7 | 1.85E7 |
* If you are not familiar with the notation, 1E6 is 1 time 10 to the power of 6. Essentially how many zeros need to be added.
Ipanema Beach estimates the probability of the tax rate reduction occurring at 50%. Ipanema Beach uses a discount rate of 10% evaluating potential capital investments.
Present value factors are as follows:
| Year | PV Factor |
|---|---|
| 1 | 0.9091 |
| 2 | 0.8264 |
| 3 | 0.7513 |
The U.S. operation will distribute 100% of its after-tax annual cash flow to Ipanema Beach as a dividend at the end of each year. The terminal value of the investment at the end of three years is estimated to be US$25,000,000.
Neither the dividends nor the terminal value received from the U.S. investment will be subject to a Brazilian income tax.
Exchange rate between the Brazilian Real and USD are
| Year | Reals to USD |
|---|---|
| 1 | 5.4 |
| 2 | 5.3 |
| 3 | 5.5 |
Questions:
1. Determine the expected
2. If, after receiving new information, the company expects the probability of the tax rate reduction to be higher than originally expected, what would happen to the NPV? Would it increase or decrease and why?
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