Wiley International is considering investing in Brazil for many reasons. Brazil is forecasted to be the sixth largest economy in the world by the end of 2015. In addition to being the second largest United States trading partner in the hemisphere. Brazil’s ability to control inflation over the past five years has renewed confidence in the Brazilian economy and financial markets, making it a large potential emerging market. Another reason Brazil is appealing to Wiley, is because of its workforce who are known to be very technically advanced and flexible, which would facilitate Wiley’s ambitions in the manufacturing industry. Currently, Brazil’s person per car ratio is 9 to 1, in comparison to developed countries 2 to 1 ratio this is not good for automobile manufacturers as they want more people in their cars. However, with such a growing economy and foreign auto import taxes circa 70%, domestic car manufacturing is most likely to boom in the next few years due to these factors.
Advantages to operating in Brazil vary. An advantage would be having a manufacturing foothold in one of the world biggest emerging markets. In addition to its skilled and flexible workforce, Wiley’s Brazilian branch sees a large need for fractional horsepower engines from Brazilian auto makers. The problems with this project however lie in the rates and finances of this project. The internal rate of return is being calculated using Brazilian Reals when applied to the cash flows. Additionally, the inflation rate being used was also the Brazilian inflation rate of 8%. All in all, the controls being used were all in terms of the Brazilian economy. Therefore any profits would be subject to tax and currency exchange once repatriated to the United States if Wiley decided to do so. A questionable move was that of using the 40% United States tax rate over the 20% Brazilian rate because Wiley would need to find out if its profits would be taxed twice, once by the Brazilian government and then again by the United States if the profits were to be repatriated to the US. The double taxation would leave them with a different figure than that of just picking the higher tax to play it safe.
The five year life span of this project for Wiley in my opinion does not look attractive. If there were better financial plans set into place the proposal would be much more appealing. But as Esposito has his concerns, so do I. There seems to be way too many potential implications and miscalculations. Internal rates of return can be misleading and should not be used to rate mutually exclusive projects. Additionally, without a clear indication of which discount rate should be used, this project may be a complete bust without management knowing. The internal rate of return assumes that there will be a reinvestment of short-term cash flows in projects with equal rates of return. Therefore without this reinvestment, the internal rate of return overstates the annual corresponding rate of return for a project whose temporary cash flows are reinvested at a rate lower than the calculated internal rate of return figure. This presents a huge issue, especially for projects with large rates of return, since there is frequently, like in this case, not another project available in the following term that can earn the same rate of return as the first project. In addition, the internal rate of return does not consider the cost of capital, unlike the Modified Internal Rate of Return. Therefore, without evidence of all these issues taken into consideration, I suspect there are huge holes in the calculation of this project which may lead Wiley down a bad road in Brazil. Lastly, this project is only projected to be profitable for 5 years. This is also not good because after five years all the equipment and facilities will be deemed obsolete. If this is the case Wiley may become obsolete during the automobile boom that firms are expecting and potentially miss out on their anticipated gold rush.
I would use the US 9%, discounted rate as there are less to no foreign exchange risks and political risks associated with that rate whereas the foreign-based rates may not include all non-quantifiable threatening factors. Even after taking this into account, I still feel it does not adequately capture the risk being taken by investing in this project in Brazil. The Japanese supplier I believe definitely makes the viability of the project much easier as they are offering a lower interest rate and thus a lower cost of capital.
As Esposito, I would not accept this project. I would push for further, clearer and more dependable calculations to be made. The internal rate of return calculation simply is not enough for the approval of a project like this where there are numerous variables unaccounted for. Although lucrative, with the data given, as Esposito I would not feel comfortable approving this project.
Higgins, Robert. Wiley International – Richard Ivey School of Business University of Western Ontario. Ed. Paul Bishop and Stephen Sapp. London Ontario: Ivey Management Services, 2005. Print.