PepsiCo recently decided to invest more than $300 million for expansion in Brazil. Brazil offers considerable potential because it has 150 million people and their demand for soft drinks is increasing. However, the soft drink consumption is still only about one-fifth of the soft drink consumption in the United States. PepsiCo’s initial outlay was used to purchase three production plants and a distribution network of almost 1,000 trucks to distribute its products to retail stores in Brazil. The expansion in Brazil was expected to make PepsiCo’s products more accessible to Brazilian consumers.
a. Given that PepsiCo’s investment in Brazil was entirely in dollars, describe its exposure to exchange rate risk resulting from the project. Explain how the size of the parent’s initial investment and the exchange rate risk would have been affected if PepsiCo had financed much of the investment with loans from banks in Brazil.
b. Describe the factors that PepsiCo likely considered when estimating the future cash flows of the project in Brazil.
c. What factors did PepsiCo likely consider in deriving its required rate of return on the project in Brazil?
d. Describe the uncertainty that surrounds the estimate of future cash flows from the perspective of the U.S. parent.
e. PepsiCo’s parent was responsible for assessing the expansion in Brazil. Yet, PepsiCo already had some existing operations in Brazil. When capital budgeting analysis was used to determine the feasibility of this project, should the project have been assessed from a Brazilian perspective or a U.S. perspective? Explain.