CEMEX ENTERS INDONESIA

In early 1998, Cementos Mexicanos (CEMEX)1 is considering the construction of a cement manufacturing facility on the Indonesian island of Sumatra. The project, Cemex Indonesia, being considered is a FDI (wholly owned Greenfield investment) with a total installed capacity of producing 20 million metric tones of cement per year (mmt/y). Although that is large by Asian production standards, Cemex believes that its latest cement manufacturing technology would be most efficiently utilized with a production facility of this scale. The company has two reasons for undertaking the project. First, it wants to initiate a productive presence in the South Asia given the future prospects2 of numerous infrastructural developmental projects and excellent growth in the region. An early entry will position the company to take advantage from the future developments in the region. Second, the Cemex in long-run wants its Indonesian plant to act as a produce-for-export site due to the strong growth prospects of Indonesian economy. CEMEX Cemex, the worlds third-largest cement manufacturer, is an MNE headquartered in an emerging market but competing in a global arena. The firm competes in the global marketplace for both market share and capital. The international cement market, like markets in other commodities such as oil, is a dollar-based market. For this reason, and for comparisons against its major competitors in both Germany and Switzerland, Cemex considers the US Dollar is its functional currency. Cemexs shares are listed in both Mexico City and New York (OTC: CMXSY). The firm has successfully raised capital both debt and equity outside Mexico in US Dollars. Its investor base is increasingly global, with the US Share turnover rising rapidly as a percentage of total trading. As a result, its cost and availability of capital are internationalized and dominated by US Dollar investors. Ultimately, the Cemexs Indonesian project will be evaluated in both cash flows and capital cost in US Dollars. CEMEXs INDONESIAN PROJECT The detailed estimates on various aspects of project are stated below: Capital Investment: The estimated cost of building a new cement manufacturing capacity anywhere in the industrial countries is roughly around $150/tonne of installed capacity. However, Cemex believes that in developing countries like Indonesia, the cost of constructing a state-ofthe-art production and shipment facility is around $110/tonne3 of installed capacity. Cemex was considering setting up a 20 million mt 4/year capacity. It will take about a year to build the plant, with actual operations commencing at the beginning of year 1.
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Cemex is a real Company. However, the Greenfield investment described here is hypothetical. Currently Indonesian economy is in depressed state as a result of financial crisis that erupted in Asia and led to the sharp declines in the currencies, stock markets, and other asset prices of a number of Asian countries 3 Tonne or metric tonne (mt) is a measurement equal to 1000kg. 4 Million metric tonne is also called as megatonne

Property, Plant and Equipment The expected value of investment in the property, plant and equipment (PP&E) in the production and shipment facilities is Rp 17.6 trillion. The Indonesian Tax Authorities permitted the foreign companies to depreciate the PP&E over a very short span of ten years to attract the foreign investment into the country. Assume Corporate Income Tax Rates of 35% and 30% in Mexico and Indonesia, respectively. Exchange Rates The prevailing spot rate is Rp.10,000/US$. Cemex assumes that the changes in Rp/US$ exchange rate during the life of its Indonesian Project will be as per the Purchasing Power Parity (PPP) relationship. The projected inflation rates for Indonesia and the United States are 30% per annum and 3% per annum, respectively, throughout the project period. Financing The Indonesian Government has only recently deregulated the heavier industries to allow foreign ownership. The massive capital investment required for the Indonesian project will be financed with 50% equity (all from Cemex) and 50% debt (Cemex providing 75% and a bank consortium arranged by the Indonesian Government providing the remaining 25%). The risk-free rate and market risk premium of US capital market is 6% and 7%, respectively. The Cemexs equity beta is 1.5. As per its credit rating, Cemex has to pay a credit premium of 2% over the risk-free rate to raise the required corporate debt. Cemex perceives that all new expansionary projects are inherently more risky than the firms ongoing projects. Hence, Cemex requires an additional yield of 3% on the domestic new expansionary projects, and 6% more for the international expansionary projects, over and above its current weighted cost of capital. The parent company has a target debt equity ratio of 4:6. The capital infused into the project by the parent company Cemex is raised by it, roughly in the same debt/equity proportions as the consolidated firm, 40% debt (D/V) and 60 % equity (E/V). The risk-free rate and market risk premium of Indonesian capital market is 33% and 7% respectively. The three-step unlevering and relevering the beta procedure estimated the Cemex Indonesias equity beta to be 1.0. The Cemex Indonesia has to pay a credit premium of 2% over the risk-free rate to avail the eight-year loan, in Rupiah, being arranged by the Indonesian Government from a local bank consortium. The majority of the debt, however, will be provided by the parent company, Cemex. After raising the capital in its own name, Cemex will relend the capital to Cemex Indonesia. The loan is denominated in US$, 5 years maturity, with an annual interest rate of 10%. The interest payments by the Cemex Indonesia are fully deductible against corporate tax liabilities. Revenues Given the depressed state of Indonesian economy and hence the lower domestic demand of cement, the existing current cement manufacturing capacity in Indonesia was already producing surplus cement than the requirement of the local market. Hence, all sales from the Cemexs Indonesian project are planned to be in form of exports only. The capacity

20 mmt/year is expected to be utlized up to --- 40% level in 19995, 50% level in 2000, and 60% level in the following years. Cement produced will be sold in the export market at $58/tonne (Delivered) and this price is likely to remain same over the life of the project. Costs The cash costs of cement manufacturing (Labour, Materials, Power, etc.) are estimated at Rp115,000/tonne in 1999 and thereafter rising at the rate of inflation (30% per year). Additional production costs of Rp20,000/tonne for 1999 and rising at the rate of inflation per year. As a result of all production being exported, ship-loading costs of $2.00/tonne and shipping of $10.00/tonne must also be included. Note that these costs are originally stated in US Dollars, and for the purposes of Cemex Indonesias Income Statement, they must be converted to Rupiah terms. This is the case because both ship-loading and shipping costs are international services governed by contracts denominated in dollars. As a result, they are expected to rise over time only at the US Dollar Rate of Inflation (3%). Additional expenses include: a yearly license fee has to be paid by the Cemex Indonesia to the parent company @ 2.0% of the yearly sales; and general and administrative expenses for Indonesian operations of 8.0% per year (growing at 1% per annum). Working capital The receivables in the export market of cement industry average at 60 to 65 Days Sales Outstanding (DSO). The smooth production process will require that inventories be maintained at 65 to 70 DSO. The payables and trade credit permissible are also relatively longer for the cement Indonesian manufacturers at 120 DSO. Repatriation and Taxes Cemex Indonesia is permitted to distribute 50% of the years net income as dividend. However, a 15% withholding tax6 is to be paid to the Indonesian Government before repatriating the dividends to the parent company Cemex in the Mexico. The withholding tax rate on: license fee is 5%, and on interest payments is 10%. There are no withholding taxes on the principal repayments. Mexico does not tax repatriated earnings since they have already been taxed in Indonesia.7 Terminal Value Cemex disposes off the project at the end of the five years to a local buyer at its terminal value and no withholding taxes are levied on it. Cemex will be able to sell Indonesian Subsidiary to a local buyer at the end of five years at a price equal to the present value of a net operating cash Flow (NOCF) after the year five. It is assumed that NOCF from fifth year onwards does not experience any growth and remain equal to the fifth year NOCF forever. Case Questions:
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This assessment is based on the fact that existing cement manufacturers in the country are averaging only 40% of capacity. 6 Statutory withholding taxes on international transfers are set by bilateral tax treaties, but individual firms may negotiate lower rates with governmental tax authorities. 7 Some countries further charge taxes on the repatriated earnings. For example, United States levy a contingent tax on repatriated earnings of foreign source income. This is the case of double taxation.

1. Project the Rp/US$ exchange rate assuming that Purchasing Power Parity (PPP) holds for the Rp/US$ exchange rate for the life of the Indonesian Project. 2. Prepare the Cemex Indonesias a. Debt service schedules and Foreign exchange gains/losses from 1998 to 2003 b. Pro forma income statement from 1998 to 2003 3. Evaluate the Cemex Indonesia project from a. The Cemex Indonesia angle b. The CEMEX angle