Question: What is the maximum amount of money Brasilia should invest? The Gibson
ID: 2655713 • Letter: Q
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Question: What is the maximum amount of money Brasilia should invest?
The Gibson Company is a United States (US) firm that is considering a joint venture with Brasilia, DF, a Brazilian firm that grows and processes coffee beans. Gibson has a patent for a new coffee processing method. This intellectual property is motivating Gibson to expand beyond importing coffee to engaging in a joint venture to process the coffee. Gibson will invest $8 million in the proposed joint venture project, which will help to finance Brasilia 's production using the newly patented process.
The Brazilian government has guaranteed that the after-tax profits (denominated in Reals, the Brazilian currency) can be converted to US dollars at the current exchange rate and sent to the Gibson Company each year. Current exchange rates can be found at http://www.oanda.com.
For each of the first five years, 60 percent of the total profits will be distributed to Brasilia, while the remaining 40 percent will be converted to dollars to be sent to Gibson. The income tax rate for the joint venture will be 10%. However, the Brazilian government is considering raising the income tax rate to 30%. At the present time, the Brazilian government doe not impose a separate income tax on profits sent out of the country. However, the Brazilian government is considering imposing an additional 10 percent income tax on profits distributed to a foreign company. Assume that there are no other forms of tax. After considering the taxes paid in Brazil, assume an additional seven percent tax imposed by the US government on profits received by Gibson Company.
The expected total profits resulting from the joint venture per year are as follows:
Year
Total Profits from Joint Venture (in BRL)
1
40 million
2
60 million
3
70 million
4
90 million
5
120 million
Gibson's average cost of debt is 6 percent before taxes. Its average cost of equity is 9 percent. Assume that Gibson’s US income tax rate is 10 percent. Gibson’s capital structure is 70 percent debt and 30 percent equity. Gibson adds between 2 and 5 percentage points to its cost of capital when deriving its required rate of return on international joint ventures. Gibson plans to account for country and other risks within its cash flow estimates.
Question: What is the maximum amount of money Brasilia should invest?
Year
Total Profits from Joint Venture (in BRL)
1
40 million
2
60 million
3
70 million
4
90 million
5
120 million
Explanation / Answer
Brasilia benefit receiving the 60 percent of joint venture profit and by the processing technology and acquiring the new equipment. After check required rate of return brasilia should invest. Assume that minimum required return is 12 percent.
Calculation of maximum amount of money Brasilia should investment as follow....
Year
1
2
3
4
5
Total
JV Profit BRL
$40,000,000
$60,000,000
$70,000,000
$90,000,000
$120,000,000
$380,000,000
Brasilia 60%
24,000,000
36,000,000
42,000,000
54,000,000
72,000,000
228,000,000
Assume 10% tax
2,400,000
3,600,000
4,200,000
5,400,000
7,200,000
22,800,000
After tax Profit
21,600,000
32,400,000
37,800,000
48,600,000
64,800,000
205,200,000
Present Value
$19,285,714
$25,829,082
$26,905,293
$30,886,179
$36,769,260
$139,675,528
The maximum investment should be $139,675,528 which is the present value of the Brasilia cash inflows.
Year
1
2
3
4
5
Total
JV Profit BRL
$40,000,000
$60,000,000
$70,000,000
$90,000,000
$120,000,000
$380,000,000
Brasilia 60%
24,000,000
36,000,000
42,000,000
54,000,000
72,000,000
228,000,000
Assume 10% tax
2,400,000
3,600,000
4,200,000
5,400,000
7,200,000
22,800,000
After tax Profit
21,600,000
32,400,000
37,800,000
48,600,000
64,800,000
205,200,000
Present Value
$19,285,714
$25,829,082
$26,905,293
$30,886,179
$36,769,260
$139,675,528
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