Problem:
It is September, 1990 and Detroit Motors of Detroit, Michigan, is considering establishing an assembly plant in Latin America for a new utility vehicle it has just designed. The cost of the capital expenditures has been estimated at $65,000,000. There is not much of a sales market in Latin America, and virtually all output would be exported to the United States for sale. Nevertheless, an assembly plant in Latin America is attractive for at least two reasons. First, labor costs are expected to be half what Detroit Motors would have to pay in the United States to union workers. Since the assembly plant will be a new facility for a newly designed vehicle, Detroit Motors does not expect any hassle from its U.S. union in establishing the plant in Latin America. Secondly, the chief financial officer (CFO) of Detroit Motors believes that a debt-for-equity swap can be arranged with at least one of the Latin American countries that has not been able to meet its debt service on its sovereign debt with some of the major U.S. banks.
The September 10, 1990, issue of Barron's indicated the following prices (cents on the dollar) on Latin American bank debt:
Brazil 21.75
Mexico 43.12
Argentina 14.25
Venezuela 46.25
Chile 70.25
The CFO is not comfortable with the level of political risk in Brazil and Argentina, and has decided to eliminate them from consideration. After some preliminary discussions with the central banks of Mexico, Venezuela, and Chile, the CFO has learned that all three countries would be interested in hearing a detailed presentation about the type of facility Detroit Motors would construct, how long it would take, the number of locals to be employed, and the number of units that would be manufactured per year. Since it is time-consuming to prepare and make these presentations, the CFO would like to approach the most attractive candidate first. He has learned that the central bank of Mexico will redeem its debt at 80 percent of face value in a debt-for-equity swap, Venezuela at 75 percent, and Chile at 100 percent. As a first step, the CFO decides an analysis based purely on financial considerations is necessary to determine which country looks like the most viable candidate. What do you advise?