Home Depot is considering setting up a store in Chile. The store requires an initial investment of 4500 million pesos for land, building and fixtures. Home Depot plans to borrow 150 million pesos at an interest rate of 12.02% using a 10-year bullet term loan. The store has an economic life of 10 years. Depreciation on the store will be computed on a straight-line basis with a salvage value of 1000 million pesos. The store is expected to generate revenue of 8000 million pesos in year 1 based on average price of 1000 pesos and volume of 8 million. Thereafter, revenue will grow at 12% per year for the remaining 9 years. The fixed cost in year 1 is estimated to be 2679 million and variable cost is 50% of revenue. Working capital requirements are estimated to be 10% of total revenue and the working capital investment will be made at the beginning of the year. At the end of the project, the entire working capital will be recouped. To evaluate the viability of this foreign investment, the CFO of Home Depot has obtained the following financial information for the project evaluation.

Should Home Depot invest in the project?

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Inputs Initial Investment Loan Interest rate Period of loan 4500 150 12.02% 10 Economic life 10 Salvage value 1000 Average Price of product 1000 Production Volume 8 Year 1 revenue 8000 Growth rate of revenue 12% Fixed Cost (year 1) 2679 Variable cost (year 1) 50% Working capital margin 10% Risk free rate (US$) 5% Risk premium 5.5% beta 0.76 Corporate bond spread for A- bond 1.1% Relative volatility of equity to bond market 2.2 Expected inflation rate in Chile 8% Expected inflation rate in US 2% Cost of debt (US$) 5.8% Tax rate in Chile 40% Cost of equity (US$) 9.180% Depreciation 350 Debt ratio 3.33% Peso/US$ spot rate 470 Inputs Initial Investment Loan Interest rate Period of loan 4500 150 12.02% 10 Economic life 10 Salvage value 1000 Average Price of product 1000 Production Volume 8 Year 1 revenue 8000 Growth rate of revenue 12% Fixed Cost (year 1) 2679 Variable cost (year 1) 50% Working capital margin 10% Risk free rate (US$) 5% Risk premium 5.5% beta 0.76 Corporate bond spread for A- bond 1.1% Relative volatility of equity to bond market 2.2 Expected inflation rate in Chile 8% Expected inflation rate in US 2% Cost of debt (US$) 5.8% Tax rate in Chile 40% Cost of equity (US$) 9.180% Depreciation 350 Debt ratio 3.33% Peso/US$ spot rate 470

Answer rating: 100% (QA)

Here are the stepbystep workings to evaluate if Home Depot should invest in the Chile project 1 Conv... View the full answer