Multinational Financial Management

Case 3

CEMEX ENTERS INDONESIA

Lecturer: Erni Ekawati, M.B.A., Ph.D

GROUP 5
Arif Oktaviano 16/407161/PEK/22396
Bayan Barlian 16/407166/PEK/22401
Fransdave Octovienos 16/407197/PEK/22432
Syifa Aulia 16/407280/PEK/22513

PROGRAM MAGISTER MANAJEMEN

FAKULTAS EKONOMIKA DAN BISNIS
UNIVERSITAS GADJAH MADA
JAKARTA
2018

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A. FACTS
It is early 1998, Cementos Mexicanos is considering the construction of a cement manufacturing
facility on the Indonesian island of Sumatra. This project would be a wholly-owned Greenfield
investment. The company has three main reasons for the project:
1. Initiate a productive presence in Southeast Asia
2. To position Cemex to benefit from infrastructural development in the region
3. The positive prospects for Indonesia to act as a produce-for-export site

Figure 1. A Roadmap to the Construction of Semen Indonesia’s Capital Budget

The first step is to construct a set of pro forma financial statements for Semen Indonesia (in Indonesian
Rupiah).
The next step is to create two capital budgets, the project viewpoint and parent viewpoint.
The following analysis was conducted assuming that purchasing power parity (PPP) holds for the
Rp/US$ exchange rate for analysis this project. The projected inflation rates for Indonesia was 30%
per annum and 3% per annum for United States inflation.
Financial assumptions are then made about:
- Capital investment
- Method of financing
- Revenue/cost forecasts

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 Cemex
Cost of Equity=6%+7%*1.5=16.5%
WACC=16.5%*60%+5.2%*40%=11.98%

Semen Indonesia
Cost of Equity=33%+6%*1.287=40.72%
WACC=(40.72%*0.7*0.25+27.184%*0.75)*
0.5 +39%*0.5=33.257%

Figure 2. Investment and Financing of the Semen Indonesia Project

(all values in 000s unless otherwise noted)

Exchange rate
Spot rate(Year 1)=10,000*1.3/1.03=12,621
Spot rate(Year 2)=12,621*1.3/1.03=15,930

Fully amortized
Repayment Per Year*PVIFA(35%,8)=2,750,000
Repayment /Y=1,058,439
Year 1
Interest Payment=2,750,000*35%=962,500
Principal Payment=1,058,439-962,500=95,939
Year 2
Interest Payment=(2,750,000-95,939)*35%
=928,921
Principal Payment=1,058,439-928,921=129,518

Figure 3. Semen Indonesia’s Debt Service Schedules and Foreign Exchange Gains/Losses

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 Gross profit/Total revenues
Licenses fees Paid to parent company
(2% of sales)

Interest on parent company debt

Tax(Year 4)=(1,507,145+1,120,846-
170,256-1,138,965)*0.3

Net income(US$)/Total revenues(US$)

Figure 4. Semen Indonesia’s Pro Forma Income Statement (millions of rupiah)

NOCF (1 g) 7,075,059( 1  0)

1 TV  5   21,274,102
K g 0.33257  0
WACC
2,372,650 3,538,319 4,645,438 5,707,736 27,722,847
2 NPV  224,000,00 0     
1.33257 1.33257 2 1.33257 3 1.33257 4 1.33257 5
Figure 5. Semen Indonesia’s Capital Budget: Project Viewpoint (millions of rupiah)

Project Viewpoint
The terminal value of the project represents the continuing value of the cement manufacturing facility
in the years after year 5. The project viewpoint capital budget indicates a negative NPV and an IRR
of only 15.4% compared to the 33.257% cost of capital. These are the returns the project would yield
to a local or Indonesian investor in Indonesian rupiah. The project, from this viewpoint, is not
acceptable.

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 • The parent viewpoint
capital budget indicates
a negative NPV and an
IRR of only -1.84%
compared to the
11.98% cost of capital
and 6% foreign
investment premium.
• The project, from
parent’s viewpoint, is
not acceptable.

Figure 6. Semen Indonesia’s Remittance and Capital Budget: Parent Viewpoint

(millions of rupiah and U.S. dollars)
Parent Viewpoint
A foreign investor’s assessment of a project’s returns depends on the actual cash flows that are returned
to it, in its own currency. For Cemex, this means that the investment must be analyzed in terms of US
dollar cash inflows and outflows associated with the investment over the life of the project, after-tax,
discounted at the appropriate cost of capital.
Parent viewpoint capital budget in two steps.
1. First, we isolate the individual cash flows, adjusted for any withholding taxes imposed by the
Indonesian government and converted to US dollars.
2. The second step, that actual parent viewpoint capital budget, combines these US dollar after-tax
cash flows with the initial investment to determine the NPV of the proposed Indonesian subsidiary
in the eyes (and pocketbook) of Cemex.
From the parent viewpoint capital budgeting, it is indicated a negative NPV of US$925.6 million with
IRR -1.84%. Based on this result, this investment is unacceptable from the parent’s viewpoint.
Sensitivity Analysis
At this point sensitivity analyses are run from both the project and parent viewpoints.
Project viewpoint measurement:
- Political risks
- Foreign exchange risks
- Other business specific potentialities
Parent viewpoint measurement:
- Adjusting discount rates
- Adjusting cash flows

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B. KEY ISSUES
From feasibility valuation, Cemex got negative NPV and IRR that is less than WACC, for both project
viewpoint and parent viewpoint. What is wrong with assumptions and projections?
C. ALTERNATIVE ASSUMPTIONS
1. Project Viewpoint
A. Including another political risk on the assumption
Another political risk that exposed to Cemex is the probability of Semen Indonesia to be taken over
by Indonesia Government (Indonesia as majority shareholders). This will changes assumptions of
projection in terms of:
 How much the Government willing to pay for taking over Semen Indonesia and the term of
payment.
 How much outstanding debt from Indonesia
 Tax consequences
B. Including another foreign exchange risk on the assumption
In our opinion, the application of flat rate on Indonesia’s inflation rate is not appropriate. This is because
Semen Indonesia project began when Indonesia started its crisis period. To have 30% inflation rate for 5
year projection means that the Indonesia economical condition would be crisis for 5 year ahead or forever
(as it was reflected in the terminal value).
Cemex should consider if the rate of rupiah was depreciated or appreciated. We try to make some
estimation on what if rupiah appreciate.
Rupiah appreciates because of the decreasing of inflation rate. For this estimation, we assume that inflation
Indonesia decrease 10% or become 20%, inflation America stays the same or 3%, WACC for project is
30.45% and 17.98% for parent. Based on these assumptions, we try to estimate NPV and IRR for both
project viewpoint and parent view point. For project viewpoint, we got a negative NPV of Rp 12,126,108
million and IRR 6.1% that is less than WACC. And for parent viewpoint, we got a negative NPV of
$921.83 million with a negative IRR 1.65%. Based on this estimation, we can assume that this investment
should be rejected.
2. Parent Viewpoint
a. Adjusting the discount rates
To increase the discount rate applicable to foreign project on the assumption that the foreign currency
might depreciate more than expected is to ignore the possible favorable effect of a foreign currency
depreciation on the project’s competitive position. Such increase in the discount rate also ignores the
possibility that the foreign currency (USD) may appreciate.
Thus, Cemex should adjust the discount rate on foreign project relative to discount rate on domestic
project that will reflect greater foreign exchange risk. The direction of this effect, can either decrease
or increase net cash inflows.

C. RECOMMENDATION
Before Cemex come into reject-the-project conclusion, we suggest the do several analysis first, as
follows:
1. Conduct Real Option Analysis
The discounted cash flow (DCF) analysis used in the valuation of Semen Indonesia, and in capital
budgeting and valuation in general, has long had its critics. Importantly, when MNEs evaluate
competitive projects, traditional cash flow analysis is typically unable to capture the strategic options
that an individual invest option may offer. This has led to the development of real options analysis.

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 Real options analysis is the application of the option theory to capital budgeting decisions. Real options
is a different way of thinking about investment values. At its core, it is a cross between decision-tree
analysis and pure option-based valuation.
Real option valuation also allows us to analyze a number of managerial decisions that in practice
characterize many major capital investment projects:
 The option to defer
 The option to abandon
 The option to alter capacity
 The option to start up or shut down
When the inflation rate going higher or lower, but NPV value is still negative. From these analyses we
can conclude that the project still must be rejected because the NPV is still negative.

2. Optimize the Plant Capacity

If the capacity for year 1 is 50%, year 2 is 60%, year 3 is 70%, year 4 is 80%, and year 5 is 90%. From
this scenario total NPV is still negative. The project still must be rejected.

3. Apply Real Inflation Rate

Indonesian hyperinflation rate should be expected to normalize, so it will decrease on the years ahead.
While the inflation rate of United States is still expected with Indonesian Rupiah exchange rate against
U.S dollar (eventhough it’s just 1-2%). Therefore, changing in the inflation rate will affect in Indonesian
Rupiah exchange rate against U.S dollars. Therefore, using the real inflation rate, this project is still not
acceptable since the NPV is negative and IRR is still lower than WACC. Cemex should not build plant
and equipment in Indonesia.

E. SOURCE

Saphiro, Alan C. (2015). Multinational Financial Management 12th Edition. John Wiley & Sons, Inc.
Moffet, Stonehill, Eitement, 2014, Fundamentals of Multinational Finance 5ed. Pearson.