Gm Plant

GENERAL MOTORS BLUE MACAW BRAZIL Plant X-Brazil Analysis Finance 570: Group Project Presented By: Abhijit Joshi, Kate Urpsirisuk, and Matthew Smith. Company Background ? Headquartered in Detroit, MI (NYSC: GM) ? CEOs – John F. Smith: Nov 1992 – May 2000 – Richard Wagoner: Jun 2000 – Present ? Founded in 1908 ? Annual global industry sales leader for 76 years ? Manufacturing facilities in 33 Countries Brazil’s Improving Economy ? Plano Real (1994) intended to stabilize Brazilian economy ? Prior to 1994, Brazilian inflation reached 2,490%, but leveled off and stood at only 4. % in 1997 ? From 1994 through 1997, Brazils GDP grew by 88% ? 1997 Per Capita GDP was at R$10,080 Plant X – Brazil Venture ? “Blue macaw” : GM’s Brazilian experiment to build low cost car.

? Plant – X : $310 Million manufacturing plant in southern Brazil. ? Innovative Manufacturing : • Costs expected to be reduced by 30% – 35% of traditional manufacturing • Produce cars with fraction of the normal capital required • Suppliers manufacture parts and assemble the car onsite Reasons For “PLANT – X” ? Brazil’s Economic Growth ?

Brazil’s Auto Market has exploded in recent years – Demand expected to hit 3 Million in 2000 from existing level of 1.

7 Million in 1997. ? “Popular Car” : Small low cost cars with 1Lt engine dominate Brazil’s auto market Predicted Demand for Macaw 800 700 600 500 400 300 200 100 1999 2000 2001 2002 2003 Units ( thousands) Brazil Demand Argentina Demand Chile Demand SWOT Analysis Strengths ?Brand Image ? Strong Industry knowledge ? Financially Robust Weaknesses ?Large Investment Required ? US Imported Engines (higher cost, Brazil tariff) Low Manufacturing Cost ?Risk Sharing ? Favorable financing terms ?VW’s dominance in auto market ?“Blue Macaw” (NOT a proven manufacturing method) SWOT Analysis Opportunities ?Access to Emerging Markets (Brazil, Argentina, and Chile) ? New Manufacturing technique ? Strong Sales Forecast ? Low Cost Leadership Threats ?Fierce Competition ?Unfavorable Tax Treatment ? Short track record of currency stability ? Unpredictable government policies Issues – Importance / Urgency Matrix Importance Urgency 1. Low Transfer Pricing 1. 2. High

Reliance on suppliers Rising manufacturing costs due to inflation Currency Hedging “Blue Macaw” Project’s Financial Viability Low 1. High 2. Issue To analyze the Financial Viability of GM’s Plant-X to justify the firm’s large investment Financial Viability Cause And Effect Taxes Inflation Rates, Exchange Rates WACC (Hurdle Rate) Project’s Financial Viability Exchange Rate Pass – Through Manufacturing Costs Market Growth / Market Share Decision Making Criteria 1. Payback Period – Must be under 5 years 2. Net Present Value (NPV) – Positive NPV 3.

Internal Rate of Return (IRR) – IRR greater than the GM defined hurdle rate Cash Flow Calculation 1. Prepare Income Statement 2. Add back non-cash items (Depreciation) 3. Reserve for 1. 5% target cash level 4. 20% Parent company’s dividend Net Income and FCF $600 $505 $521 $500 $400 $395 Millions (R$) $305 $300 $200 $100 $181 $311 $288 Net Income Free Cash Flows $167 $208 $144 $1999 2000 2001 2002 2003 Capital Asset Pricing Model (CAPM) Ke = rf + ? (rm-rf) Ke = 12. 84% Where: rf = 0. 07 rm = 0. 143 ? = 0. 8 WACC Ko = (1-L) Ke + L id (1-t) Pretax Rate of Return Debt Equity 7. 0% After-tax Rate of Return 4. 81% 12. 84% Weight 0. 35 0. 65 GM’s WACC International Premium WACC 0. 016835 0. 08346 10. 03% 6% Plant X’s WACC 16. 03% Payback Period 5 4 5 Years 3 2 1 0 Regular Payback Period Discounted Payback Period Hurdle Period 1. 9 2. 1 Net Present Value (NPV) Discount Rate (Hurdle Rate) Initial Investment • 16. 03% • R$ 290 M • R$ 426,643,525 NPV IRR • 63. 954% Sensitivity Analysis of Demand GM Forecast Demand Regular Payback Period Discounted Payback Period NPV (R$) IRR 1. 9 2. 1 427 M 64% 75% Anticipated Demand 2. 2 2. 7 244 M 45% Increase (Decrease) 0. years 0. 6 years (183 M) (19%) Sensitivity Analysis Exchange Rate 2. 0000 1. 7650 1. 8000 1. 6454 1. 8932 Exchange Rate (R$/$) 1. 6000 1. 3699 1. 4000 1. 2050 1. 2000 1. 0700 1. 0914 1. 5067 GM Forecast PPP Parity Forecast 1. 0000 1. 1132 1. 1355 1. 1582 1. 1814 1. 2050 0. 8000 0. 6000 1997 1998 1999 2000 2001 2002 2003 Expected Dividends to Parent 100 90 80 70 87 88 Millions US($) 60 61 59 66 GM Forecast 50 40 30 20 10 0 1999 26 33 54 PPP Parity Forecast 41 42 2000 2001 2002 2003 Hedging Exchange Risk Historical Perspective: • The Cruzeiro Real was replaced by Real (R$) in 1994 . 3 1. 2 1. 2 R$/US$ 1. 1 1 1 • The new R$ became a pegged currency 0. 9 0. 918 0. 8 1995 1996 1997 R$/US$ Source: www. cme. com Hedging Exchange Risk Exchange risk: It is the variance in expected cash flows arising from exchange rate changes Potential Hedging Targets: – Expected Cash Flows: Dividends to be paid to the parent over the period of 5 years (1999 – 2003) – Capital Investment: Total expected outlay of R$290 million, with R$65 million in 1997, and R$225 million in 1998 – Debt: R$18 million loan provided in LC for constructing Project-X

Hedging Exchange Risk Reasons for Hedging: – R$ could become a floating currency. – Based on PPP, high Inflation rate could depreciate R$. – Past economic challenges faced by the Brazilian government. Hedging Methods Forward contracts: Advantages: –Flexible contract amount Issues: –Obligation to take physical delivery at maturity and deal at a specific rate – Forecasted cash flows to the parent are not certain. Lower levels of cash flows would increase hedging costs. Hedging Methods Future contracts: Advantages: Low cost with high degree of leverage –Freedom to liquidate contract before maturity – No obligation to take physical delivery at maturity Issues: –Standardized contract amount Hedging Methods Currency Options: Constraint: – R$ is not available for trading currency options. Strategy: – Low upfront hedging costs, and high degree of leverage makes Future Contracts an attractive hedging instrument for “Blue Macaw” project. Conclusion Based on Decision Criteria, we believe the “Blue Macaw” project has potential to add value to GM’s bottom line Questions? Thanks for Listening!