TB0467

Lena Chua Booth

Roy C. Nelson

3P Turbo—Cross Border Investment in Brazil

“Brazil’s Senate voted 61-20 to remove President Dilma Rousseff from office, finding her guilty of breaking
budgetary laws in an impeachment trial,” blared the CNN Money video headline that went across the computer
screen of Jason Stacks, the founder of 3P Turbo, on August 31, 2016. This news added to the political turmoil
rocking Brazil lately. Among recent events was the high-profile Petrobras corruption scandal that had ensnared
some of the country’s biggest political and business leaders. The political crisis came in the midst of Brazil’s
worst recession in at least two decades. As a country with economic growth tracked very closely to commodity
prices, more so than any other nation in the world, the tumble of commodity prices and the Chinese economic
slowdown had taken a toll on Brazil’s economy.1 The country was experiencing a high unemployment rate of
10.2 percent, with ten million people unemployed in 2016 compared to only seven million a year ago.2 This was
compounded by high inflation and interest rates, and plummeting consumer spending. Its debt had also been
downgraded to junk status. The country’s economic hardship had led thousands to protest on the street since
the beginning of the year.

Back in the United States, Jason Stacks had been contemplating setting up a facility to manufacture
automobile turbochargers in the city of Itirapina, state of São Paulo, Brazil. He hadn’t been able to export
aftermarket turbochargers to Brazil, as the country only allowed the import of two categories of used car parts:
(1) parts for antique vehicles, and (2) the remanufactured parts from the original manufacturers of the vehicles.3
He had engaged with a consultant to gather some revenue and cost projections for the investment, outlined in
Exhibit 1. Even though the automobile industry had experienced severe contraction in the last three years, and
2016 was projected to be a down year as well, Jason expected the trend to reverse in 2017. The political and
economic fallout could possibly lead to a drastic reform that might turn the country’s economy around. However,
with all the uncertainties the country faced, he really needed to consider the proposed investment very carefully.

Company Background
3P Turbo is a privately held turbocharger manufacturer based in the Midwest of the United States. It manufactured
aftermarket turbochargers which are powerful, precise, and of high performance, hence the name 3P. Founded
in 1992 by Jason Stacks, a former Honeywell engineer who had a passion for race cars and their performance,
3P Turbo had expanded dramatically over the years, shipping to the entire U.S. and around the world. It had
a wide range of product lines ranging from high performance turbochargers to products such as fuel injectors,
wastegates, and heat exchangers, with thousands of SKUs for consumers to choose from. Since inception, 3P
Turbo had manufactured award-winning turbochargers for race cars, and for original equipment manufacturers
(OEMs) such as Fiat Chrysler. It provided full technical support for every single product it sold. With its superior
product quality and customer service, 3P Turbo became an ISO9001:2008-certified company in 2013.

Turbochargers were once used only in sports and luxury cars built to deliver high performance. Today, almost
all vehicles, from compact cars to pickup trucks, could be equipped with turbochargers. A turbocharger reuses
hot exhaust gas to increase engine power in a small space, hence allowing smaller engines to be used in vehicles
without sacrificing power and performance. Smaller engines improve fuel efficiency, helping carmakers move
closer to the average gas mileage of 54.5 MPG by 2025, a target set by the Environmental Protection Agency in

1
Ruchir Sharma, “Impeachment Won’t Save Brazil,” Wall Street Journal, April 18, 2016.
2
Patrick Gillespie, “Brazil Loses Millions of Jobs Amid Political Crisis,” CNN Money, April 20, 2016.
3
“2016 Top Markets Report—Automotive Parts,” International Trade Administration (ITA).
Copyright © 2016 Thunderbird School of Global Management, a unit of the Arizona State University Knowledge Enterprise.
This case was written by Professors Lena Chua Booth and Roy C. Nelson for the sole purpose of providing material for class
discussion. It is not intended to illustrate either effective or ineffective handling of a managerial situation. Any reproduction, in
any form, of the material in this case is prohibited unless permission is obtained from the copyright holder.
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 the United States. With the fuel efficiency made possible by turbochargers, some analysts argued turbochargers
had unintentionally slowed the adoption of alternative fuel vehicles.4

The widespread use of turbochargers in vehicles had resulted in an increased demand for products sold by
3P Turbo. Sales of 3P Turbo went up three-fold in the last five years. With the regulatory pressure and consumers’
love of power and fuel economy in their vehicles, the turbocharger industry was expected to grow dramatically.

Brazil’s Business Environment in 2016: A Political and Economic Assessment

By the end of August 2016, Brazil’s economic and political situation seemed highly unfavorable for investment.
Economically, the country was doing far worse than it had in the relatively recent past. From a growth rate of
7.5 percent in 2010, Brazil was now experiencing its worst recession in decades. Economic growth declined by
3.8 percent in 2015 and was projected to fall by at least another 3 percent in 2016. The inflation rate surpassed
10 percent from late 2015 to early 2016 and had since subsided some (see Exhibits 3a and 3b), and the budget
deficit, which had reached 10.5 percent of GDP in 2015, seemed likely to remain almost as high in 2016.5
Unemployment had risen to over 10 percent.

Politically, the country was in turmoil. Since early 2015, millions of Brazilians all over the country, disgusted
with what increasingly appeared to be widespread government involvement in the corruption scandal involving
Petróleo Brasileiro (Petrobras), had participated in demonstrations demanding that the president of Brazil, Dilma
Rousseff, either resign or be impeached. After a long investigation and trial beginning in May 2016, the Brazilian
Senate voted 61-20 on August 31, 2016, to impeach Rouseff. This meant that her Vice President, Michel Temer,
who, from the more centrist, business-friendly Partido do Movimento Democrático Brasileiro (PMDB) party, but
was also under investigation in the Petrobras scandal and very unpopular in his own right, would replace her.6

Contributing to Brazilians’ overall frustration with the economic and political situation was that it arose
after Brazil appeared finally to be on the right track. The country had achieved relative economic stability and
sustained economic growth beginning in the mid-1990s, and had maintained those outcomes for over fifteen
years. During his time in office, President Fernando Henrique Cardoso (1995-98; 1999-2002) made great strides
in correcting many of Brazil’s economic problems. He significantly reduced Brazil’s chronic budget deficits, and
managed to stop the practice of financing those deficits by printing large amounts of currency, the underlying
cause of Brazil’s hyperinflation. These policies reduced Brazil’s inflation rate from over 5,000 percent per year
to under 5 percent per year. By the end of his presidency, Cardoso had established what came to be known as
the tripod of policies that created economic stability and sustainable economic growth: fiscal discipline, inflation
targeting (having a relatively independent Central Bank set a target inflation rate, and raise interest rates to keep
inflation in check if it rose above that level), and a floating, market-determined exchange rate.

Cardoso’s successor, Luis Inácio (Lula) da Silva (2003-2006; 2007-2010), who had initially opposed Cardoso’s
policies as Cardoso’s chief opponent in the 1994 and 1998 presidential elections, later came to see that these policies
worked. They had ended Brazil’s high inflation rates, produced lasting economic growth, and created millions of
jobs. Seeking to maintain this success, after becoming president himself, Lula maintained Cardoso’s policies (or
as Cardoso said, he “rode the wave” that Cardoso had started). He even improved Brazil’s fiscal discipline further,
by enacting a reform that set a fixed retirement age for Brazilians to receive full government retirement benefits
(before, they had been able to retire with full benefits after only 30 years of employment, no matter what their
age at retirement). This reform contributed greatly to helping Brazil keep its budget deficits at manageable levels
(well below 5 percent of GDP), while Lula’s Central Bank president, Henrique Meirelles, the former president
of BankBoston, actively used inflation targeting to keep inflation below the target level of 4.5 percent.

These pro-business policies, combined with rapid growth in China that significantly increased demand for
Brazilian exports of iron ore, soybeans, meat, tobacco, and coffee during the commodity boom of 2003-2010,
contributed to Brazil’s relatively high growth rates during Lula’s presidency, averaging over 4 percent per year.
4
Lawrence Ulrich, “Carmakers Find That Turbos Are a Powerful Path to Fuel Efficiency,” New York Times, February 26, 2015.
5
Economist Intelligence Unit, “Country Forecast: Brazil,” September 2016.
6
Simon Romero, “Brazil’s Vice President, Unpopular and Under Scrutiny, Prepares to Lead,” New York Times, April 21, 2016
(<http://www.nytimes.com/2016/04/22/world/americas/micheltemer-prepares-to-lead-brazil.html>, accessed April 30, 2016).

2 A06-16-0013
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 In addition to this sustained growth, Lula’s Bolsa Família program, which gave a small monthly stipend to poor
families if they kept their children in school and got them vaccinated, helped produce a dramatic reduction in
Brazil’s poverty rate.7 Having already decreased by 24.3 percent during the Cardoso years, the poverty rate fell
by another 27.7 percent during Lula’s first term alone.8 From 2003-2011, more than 35 million Brazilians left
poverty to join the middle class, bringing the middle class to slightly more than 50 percent of the population for
the first time in Brazil’s history.9 It was perhaps no surprise that Lula ended his second term with an unprecedented
80 percent approval rating.

However, things changed dramatically during the presidency of Dilma Rousseff (2011-14; elected to a
second term, 2015-18—but impeached in 2016). Rousseff’s policies were far more interventionist than those
of her predecessors, Cardoso and Lula. This may, in part, have been due to her very different background and
worldview. Although she grew up in a middle-class family, Rousseff became radicalized during the early years of
the military regime, and joined a leftist guerilla group committed to the overthrow of the military government.
She was later arrested and tortured by the military officials while she was imprisoned. After leaving prison, she
studied economics at various universities, worked in state government, and eventually became Minister of Energy
in the Lula Administration, and soon after that his Chief of Staff. Although she had never held elected office
before, Lula’s strong endorsement virtually guaranteed her victory in the 2010 presidential campaign.

Rousseff initially said that she wanted to maintain the fiscal discipline and pro-business approach that Lula
had embraced. From the beginning of her presidency, however, she favored a more interventionist approach
to economic policy. In response to slower growth in the early days of her first term, she implemented various
government stimulus plans and other initiatives that called for large increases in spending. She significantly
increased funding for the Banco Nacional de Desenvolvimento e Social (BNDES), Brazil’s development bank,
which made loans to large corporations in Brazil at very low subsidized rates of interest. Some analysts argued
that a further problem with BNDES financing was that it crowded out private-sector lending, and most of the
loans went to large, politically well-connected corporations.10

In addition to abandoning the fiscal discipline that Cardoso and Lula had maintained, Rousseff appointed a
more activist president of the Central Bank, Alexandre Tombini, who sought to increase growth by lowering the
Central Bank’s interest rate from 14.5 percent to 7.25%. As inflation increased above the previous 4.5% target
the Central Bank had maintained before, Tombini did not immediately raise rates. Instead, Rousseff attempted
to control inflation by actively intervening in various industries, insisting that companies reduce the rates they
charged consumers. For example, in 2012, Rouseff demanded that electricity companies with concessions from
the government reduce their prices or lose their concessions. She also required Petrobras to reduce the price
consumers paid for fuel, a subsidy which cost the Brazilian government billions and was a major factor behind
Petrobras’s $44 billion in operating losses in Rousseff’s first term.11

However, Rousseff’s government stimulus plans and subsidies did not spur Brazil’s economic growth rate
in 2016; in fact, growth continued to decline. And even after the Central Bank began raising interest rates again,
Rousseff’s efforts to control inflation failed to prevent it from staying above 9 percent. While these factors alone
would be enough to cause her public approval to fall, the government’s involvement in the Petrobras scandal
helped bring her approval rating down to a low of 8 percent by mid-2016.

7
Significantly, this program did not have an adverse impact on Brazil’s fiscal discipline, since it cost the government the
equivalent of only 0.5% of GDP per year.
8
Nilson Brindão Junior and Marianna Aragão, “Miséria no Brasil cae 27.7%,” O Estado de São Paulo, September 20, 2007,
p. B14 (<http://economia.estadao.com.br/noticias/geral,miseria-no-brasil-cai-27-7-no-1-mandato-de-lula,54881>, accessed
April 29, 2016).
9
Paulo Prada, “Special Report: Why Brazil’s Middle Class is Seething,” Reuters, July 3, 2013, (<http://www.reuters.com/
article/us-brazil-middle-specialreport-idUSBRE9620DT20130703>, accessed April 29, 2016).
10
Laura Alfaro and Hilary White, “Brazil’s Enigma: Sustaining Long-Term Growth,” Harvard Business School Case, October
22, 2015.
11
Juan Pablo Spinetto, “Petrobras Lifts Fuel Prices in Petrobras Subsidy Relief,” Bloomberg News, November 6, 2014 (http://
www.bloomberg.com/news/articles/2014-11-06/petrobras-raising-prices-as-rousseff-gives-subsidy-relief>, accessed May 1,
2016).

A06-16-0013 3
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 Rousseff was not specifically accused of enriching herself in the bribery scheme, as many other politicians
had done. Nevertheless, as Lula’s Minister of Energy and later Chief of Staff, she had been chair of the Board
of Directors of the state-owned Petrobras during 2003-2010, when several members of the Board were accused
of accepting bribes. Construction companies paid these bribes to the Petrobras directors in return for generous
contracts, often far in excess of actual costs for the construction projects involved. Since the Brazilian Federal
Police began the investigation in early 2014, more and more evidence had surfaced that members of the Board,
many of whom were affiliated with Lula’s (and Rousseff’s) socialist Partido dos Trabahladores (PT, or Workers’
Party), had used millions in dollars in bribe money to help finance PT electoral campaigns at all levels, possibly
including Rousseff’s presidential campaign.

Because no solid evidence of Rousseff’s direct involvement had surfaced yet, Rousseff’s opponents in the
National Congress sought to impeach her on other grounds: a charge that she had used accounting tricks to
mislead the public about the true size of Brazil’s budget deficit when she ran for re-election in 2014. Nevertheless,
most Brazilians believed that given her role as chair of Petrobras’ board, Rousseff must have been involved in
that scandal as well. After Lula himself was arrested briefly in March 2016, and accused of receiving bribes from
some of the construction companies involved in the scandal, Rousseff attempted to give him immunity from
prosecution, at least temporarily, by appointing him to her Cabinet, a move that was blocked by Brazil’s Supreme
Court. This only contributed to the public’s negative view of the president.

In assessing the political and economic turmoil in 2016, some business executives considered waiting to
invest in Brazil until after the congressional and presidential elections in October 2018, when it seemed likely that
Brazil’s growing middle class, fed up with the widespread corruption scandal and poor economic performance
of the current government, would elect new leaders with a more orthodox, business-friendly approach. Aécio
Neves of the centrist Partido da Social Democracia Brasileira (PSDB) party (the same party to which Cardoso
belonged) had seemed to be a likely candidate to win the presidency in 2018, given that he had lost the 2014
presidential election to Rousseff by a very narrow margin. However, recent allegations had surfaced that he, too,
was involved in the Petrobras scandal.

Nevertheless, by August 2016, another PSDB candidate, Geraldo Ackmin—widely perceived to be a

highly competent, completely honest, and very pro-business governor of the state of São Paulo—had emerged
as a frontrunner in the 2018 presidential election. Brazil’s economy seemed likely to improve in 2018, and could
possibly begin to improve as soon as 2017 under the more business-friendly government of President Temer,
who would serve out the remainder of Rouseff’s term. After all, Temer had made clear that he intended to reduce
Brazil’s budget deficit, appointing moderate, centrist cabinet ministers who would be fully committed to scaling
back Rousseff’s interventionist policies and restoring sustainable growth with low inflation.12 The question was,
should Jason invest now, while the Brazilian real was still relatively weak and his competition was unlikely even
to consider Brazil, or should he wait it out until after the election in 2018?

Brazil’s Auto Industry

Despite the political and economic uncertainty in Brazil, the situation in the auto industry seemed to offer great
potential. From the 1950s onward, the Brazilian government actively sought to promote car manufacturing in
the country with high tariffs on imports and other policies, such as local content requirements, that encouraged
foreign investment. Because of these policies, Brazil developed a sizeable manufacturing capability, not only for
cars themselves—the segment of the industry dominated by foreign manufacturers—but also for auto parts,
where local manufacturers prospered.

Because of this strong government support and its own large market, Brazil became one of the top
manufacturers of cars in the world. In the last 20 years, however, countries such as China, India, and even Mexico
had begun outpacing Brazil’s production. In 2015, Brazil was the 9th largest producer of cars in the world,
according to statistics compiled by the Organisation Internationale des Constructeurs d’Automobiles (OICA).
In 2014, the main players in Brazil, in terms of market share, were Fiat-Chrysler Autos (21.3%), Volkswagen
(17.7%), General Motors (17.4%), Ford (9.3%), and Renault-Nissan (9.3%).13 However, Honda, Hyundai,
12
Tom Buerkle, “Investors Bet Big on Michel Temer—Can He Turn Brazil Around?” Institutional Investor, September 27, 2016.
13
“Automakers Market Share in Brazil in 2014, by Major Manufacturer,” Statistica (<http://www.statista.com/statistics/295145/
automotive-market-share-in-brazil-by-manufacturer/>, accessed May 1, 2016).
4 A06-16-0013
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 Tata (from India), and Chery (from China) were expected to pose increasing competition for market share for
these firms.

Significantly enhancing Brazil’s attractiveness as a location for foreign automakers was its membership in
the Mercado Comúm do Sul (Mercosul in Portuguese, or Mercosur in Spanish) customs union, which went
into effect in 1995. The Mercosul trade pact initially included Brazil, Argentina, Paraguay, and Uruguay as full
members (Venezuela joined as a full member later), while most other South American countries, including Chile,
Bolivia, Peru, Colombia, and Ecuador, were associate members.

At least in theory, anything produced in any of the full or associate member countries of Mercosul could
be traded at zero tariffs within the customs union. This meant that firms manufacturing in Brazil had access not
only to the Brazilian market, but essentially to the entire South American market, with zero tariff barriers. (In
practice, there were often exceptions to this rule.) The difference between the full members of Mercosul and the
associate members, however, was that the full members shared a Common External Tariff (CET) that averaged
14%, while the associate members were allowed to set their own external tariff rates. In some sectors, such as
automobiles, the CET was much higher, to further encourage domestic production in those sectors.

When President Rousseff increased Brazil’s tariffs on automobiles from 25% to 55% in 2012, and imposed
a quota on imports from Mexico—which had previously been granted Mercosur status for this sector—without
consulting other Mercosul members, she violated the rules of the pact. At the same time, however, she made the
possibility of exporting cars or car parts to Brazil even more difficult. As Jason knew, the only realistic way to
succeed in this sector was to manufacture the product in Brazil.

Local manufacture created the opportunity for government incentives, usually in the form of reduction in
specific taxes at the state or local level. For instance, states in Brazil could offer exemption from the ICMS tax,
a state value-added tax on sales of goods and services that varied by state and product or service, but averaged
about 16%. The highly developed state of São Paulo, which had little difficulty attracting investment, offered
no exemptions on this tax whatsoever, while poorer or more remote states might offer complete exemption from
the ICMS tax for a specified period. As part of her efforts to intervene in the market and encourage more local
production, Dilma Rousseff had created a new federal tax incentive in 2012 specifically for the auto industry
called Inovar Auto, which provided specific tax breaks for firms in the auto industry that invested locally in
innovations that produced more fuel efficiency or carbon reduction. Under this program, automakers who commit
to a 12 percent reduction in fuel consumption and 18.84 percent reduction in carbon emissions would get tax
reduction incentives.14 Despite the benefits this program provided, Jason had some concerns about it. For one
thing, although Rouseff had plans to extend it, the current scheme was scheduled to last only until 2017.15 Also,
both the EU and Japan had launched trade disputes against Brazil in the World Trade Organization (WTO) over
the program, arguing that it unfairly favored local content over imports.16

Because Brazil had such a long history with auto manufacturing, there was a highly skilled, capable work
force in this sector in the country, at least in some states, such as Minas Gerais, Paraná, and São Paulo. Brazil
was notorious for its high costs of doing business, known as the Custo Brasil or Brazil Cost, which referred to
Brazil’s complex, burdensome tax system, red tape, rigid labor laws, and poor infrastructure (especially in the
northeastern part of the country). But Jason knew that in São Paulo he would have no difficulty finding the
skilled workers he needed for his manufacturing plant.

Analysis of the Brazilian Investment Proposal

Jason examined the costs and revenue data in Brazilian real (R$) shown in Exhibit 1. The project required an
immediate cash outlay of R$130 million, of which R$10 million were to be used for training local employees,
R$20 million for site preparation and improvement, and the other R$100 million for equipment purchase. Jason
14
“2016 Top Markets Report—Automotive Parts,” International Trade Administration (ITA).
15
Roger Stansfield, “Brazil: Stimulating or Stifling Automotive,” Automotive Manufacturing Solutions, September 9, 2014
(http://www.automotivemanufacturingsolutions.com/focus/brazil-stimulating-or-stifling-automotive>, accessed October
31, 2016).
16
“Brazil: Auto Sector Faces Uphill Battle,” Oxford Analytica Daily Brief Service, April 14, 2016.

A06-16-0013 5
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 often sourced the equipment for production and assembly from a vendor in Germany. Due to the superb business
relationship, the vendor had agreed to provide seller financing up to 90 percent of the equipment cost at a very
attractive interest rate of two percent per annum. This rate was much lower than what Jason could borrow from
a German bank, a U.S. bank, or a Brazilian bank. The bank rates comparison was as follows:
Loan Rates Secured by the Equipment and 3P Turbo’s U.S. Assets
German Vendor German Bank U.S. Bank Brazilian Bank
2% 6% 8% 15%
The seller financing agreement required 3P Turbo to completely pay off the loan, both principal and interest,
over five equal installments in Euros as outlined here:
Calculation of Loan Payments Based on 2% Annual Rate
Loan Amount R$90 million or Euro 22.5 million
Spot Exchange Rates 4.00 R$/Euro 3.56 R$/USD
Forward Exchange Rate 4.20 R$/Euro 3.74 R$/USD
(in Currency Swap)
Vendor Loan Rate 2%
2017 2018 2019 2020 2021
Loan Payments (Euro) 4,773,564 4,773,564 4,773,564 4,773,564 4,773,564

With R$90 million of seller financing, the debt to equity ratio of the capital expenditure was 3:1. This was
a concern as 3P Turbo liked to maintain a much lower debt equity ratio for the company, typically about 1:1.
Unless 3P Turbo changed its desired debt equity ratio at the corporate level, future projects would need to be
financed with very little debt.

Similar to previous investments, site preparation and equipment costs were treated as capital expenditures
depreciable over five years on a straight-line basis. Training costs were expensed off in the same year the expenses
were incurred. Due to equipment becoming worn and technologically obsolete, the consultant estimated a salvage
value for the site and equipment of R$30 million at the end of the fifth year.

Like any sizable entity doing business in Brazil, 3P Turbo would be subject to a total tax rate of approximately
34 percent on the profits made each year.17 While the tax rate on corporate profits remained unchanged over
the last ten years, the capital gains tax rate had just been increased from its previous flat rate of 15 percent and
25 percent for entities from non-tax-haven and tax-haven countries, respectively. Starting January 1, 2016, the
Brazilian government imposed a tiered capital gains tax rate on all individuals and entities, domestic or foreign,
based on the following:18
Capital Gains Tax Rate in Brazil for All Individuals and Legal Entities
Tax Rate Capital Gains Amount
15% Up to R$1,000,000
20% > R$1,000,000 and <= R$5,000,000
25% > R$5,000,000 and <= R$20,000,000
30% > R$20,000,000

While the Brazilian real (R$) cash flows numbers looked promising, the risks of investing in Brazil had to be
properly accounted for to determine if the investment would create value. The cost of capital of 10 percent used
for similar projects in the U.S. would be inappropriate for this investment. Brazil had a much higher inflation
rate than the U.S. and the trend was expected to continue. The R$ revenues and costs reflected a 9 percent
inflation rate every year for the next five years. In contrast, the U.S. inflation rate forecast was at 2 percent per
year during the same period.

Decision Time
Given the size of the automobile industry, Jason was confident there would be a big market for turbochargers
in Brazil. However, there were also many local manufacturers competing in the same space. Would 3P Turbo’s
17
This 34% rate can be broken down into: 15% base rate, 10% surtax for income surpassing R$240,000, and 9% social
contributions. Source: “Corporate Tax Rate 2015,” Deloitte, August 2015.
18
“Brazil Changes Capital Gains Tax Rate for Non-Resident Entities,” Tax Insights, PwC, October 13, 2015.
6 A06-16-0013
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 superior quality, high-performance turbochargers have a competitive edge in Brazil? Would Jason be given the
opportunity to supply turbochargers to FiatChrysler for its vehicle production in Brazil, given his previous business
relationship with them? Could he get new businesses from other automakers? Quite a few foreign automakers
had set up production facilities in Brazil in recent years, partly due to the Inovar Auto program introduced by
the Brazilian government in late 2012 aiming to increase investment in Brazil and localize production. If 3P
Turbo could help OEM companies attain these thresholds with its turbochargers in a cost-effective way, it could
potentially become a preferred supplier to the automakers in Brazil. That would drastically improve the cash
flow forecast of this project as the current estimates provided by the consultant only accounted for turbocharger
sales in the aftermarket.

Besides financial viability of the project, Jason also wondered about the timing of starting this project. From
a strategic view point, would entering Brazil during this turbulent time give 3P Turbo first-mover advantage?
Should Jason wait until the automobile industry in Brazil showed signs of recovery? What about global commodity
prices and the Chinese economy, which impacted Brazil’s economy in such a big way? Would those conditions
persist and drag down the Brazilian economy further? Among all these uncertainties, Jason also wondered how
easy or difficult it would be to negotiate for government incentives under such a chaotic political environment.

A06-16-0013 7
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 Exhibit 1. Brazilian Investment Cash Flows Forecast (Price and Costs Increased by 9% Each Year)
(thousands of R$)
Year 2016 2017 2018 2019 2020 2021

Projected Volume (000) 28 30 38 44 50

 
Price Per Unit (R$) 2,400 2,616.0 2,851.4 3,108.1 3,387.8
 
Production cost Per Unit (R$) 1,050 1,144.5 1,247.5 1,359.8 1,482.2
 
Selling Cost Per Unit (R$) 300 327.0 356.4 388.5 423.5
 
Administrative cost Per Unit (R$) 100 109.0 118.8 129.5 141.2

Revenue 67,200 78,480 108,355 136,755 169,390

Production Cost (29,400) (34,335) (47,405) (59,830) (74,108)

Gross Profit 37,800 44,145 60,950 76,925 95,282

Selling Cost (8,400) (9,810) (13,544) (17,094) (21,174)

Administrative Cost (2,800) (3,270) (4,515) (5,698) (7,058)

Depreciation (24,000) (24,000) (24,000) (24,000) (24,000)

EBIT 2,600 7,065 18,890 30,132 43,050

Taxes on Profits (34%) (884) (2,402) (6,423) (10,245) (14,637)

After-tax Profit 1,716 4,663 12,468 19,887 28,413

Add Back Depreciation 24,000 24,000 24,000 24,000 24,000

Total Operating Cash Flows 25,716 28,663 36,468 43,887 52,413

Cost of building and equipment (120,000)

Cost of Training After Tax (6,600)

Salvage Value 30,000

Source: Casewriters’ estimates.

8 A06-16-0013
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 Exhibit 2. Brazilian Real per U.S. Dollar Exchange Rate from October 1996–September 2016 (R$/US$)

Source: Trading Economics. http://www.tradingeconomics.com/brazil/currency.

A06-16-0013 9
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.
 Exhibit 3a. Brazil Inflation Rate from October 2015–September 2016

Exhibit 3b. Brazil Inflation Rate from October 1996–September 2016

Source: Trading Economics. http://www.tradingeconomics.com/brazil/inflation-cpi.

10 A06-16-0013
This document is authorized for use only in Susanna Lu's ZZBU8703 International Finance - H3 2023 at University of New South Wales from May 2023 to Oct 2023.