Santa Isabel, a food company located in Chile in South America, is planning to expand its operations internationally, and is considering buying a relatively small California-based grocery chain store that specializes in South American food.
Annual revenues are expected to be a constant amount of $3,000,000 and the cost of goods, $1,500,000. General and Administrative expenses are estimated at $500,000 per year and annual depreciation expense at $300,000.
The operations in California will pay 80?% of its accounting profit to the parent firm, Santa Isabel, as an annual cash dividend. Chilean taxes are calculated on grossed up dividends from foreign? countries, with a credit for? host-country taxes already paid. The corporate income tax rate in U.S. is 28?% and the tax rate in Chile is lower at 25%. Therefore no additional income taxes will be payable in Chile.
Santa Isabel will base its valuation of the investment on after-tax dividends received at the end of each of the first three years plus a terminal value as at the end of year 3. The terminal value will be computed based on the assumption that annual after-tax dividends received by the parent in years 4 through infinity will be the same as the dividends received in year 3.
The Chilean currency is the Chilean peso and is denoted CLP$. The exchange rate against the US dollar is as follows. The current exchange rate is CLP$ 600.00?/$, and the exchange rates for the next three years are projected to be CLP$ 620.00?/$, CLP$ 640.00?/$, and CLP$ 660.00?/$, respectively.
Santa Isabel uses a cost of capital is 20% to evaluate all foreign investments. (The same discount rate is used for both annual dividends as well as the terminal cash flow.)
What is the maximum U.S. dollar price Santa Isabel should offer today for the investment?