Capital Budgeting Scenario Questions Essay

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Finance

This information will affect the opportunity cost of the decision, because the company will not have any access to the Chilean market. Well, more likely it will need to sue via the WTO over the policy, so it would eventually gain access to the Chilean market, but until that happens would be shut out. However, there are always opportunity costs associated with any decision. The decision as to whether or not the company should set up in Chile has to be made based on the merits of that decision alone. Making decisions based on speculation and worst-case hypotheticals, in particular when those are opportunity costs, is poor decision-making practice. Thus, this rumor about Matsubara should not have any influence on the decision with respect to setting up in Chile. The decision is still that setting up in Chile is expected to have a positive NPV, and should be undertaken.

Normally, it is advised that opportunity costs are included in an NPV calculation, but to do that the opportunity cost has to be legitimate, not hypothetical. Hypothetically, we could take the money not invested in Chile, go to Vegas, and win $100 million hypotheticals should only be included if they are realistic, plausible options for the company.

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In this situation, you are working with a rumor. But that rumor is tangential to the decision, because it has already been determined that we will not export to Chile. Thus, the choice remains either to set up operations in Chile, or not to set up operations in Chile. Exporting was never an option, so this hypothetical rumor (that runs counter to Chile's WTO commitments) does not affect the decision at hand.

2. This would have to be taken into consideration. Many countries have rules that govern cash outflows. It would be illegal, however, to mandate that capital retained in Chile must only be invested at 2%. You would reinvest it elsewhere in the Chilean economy. The entire point of such laws is to encourage retaining earnings in the host country.

But to take this absurd scenario at face value, 2% is a negative real return as Chilean inflation rates are in the 4.x range for 2015. This mandate would represent negative cash flow. That loss on investment must be included, because it is incremental to the decision, and is known. This cost would then have to be built into the analysis, and….....

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