Assignment 4: Long-Term Assets and Liabilities Management International Finance: FIN 535

Assignment 4: Long-Term Assets and Liabilities Management Determine Gandors cost of capital In order to determine the cost of capital for Gandor we must use the below formula to solve for the Equity costs and Debt costs (Madura, 2010).
WACC kc= (D/D+E)kd(1-t)+(E/D+E)ke =(60%)*(13.8%)*(70%)+(40%)*(18) 5.8%
Cost of Capital

+ 13.0%

7.2%

Based on the above cost of capital the required rate of return is 17% because, as stated in the problem, Gandor adds 4% to the cost of capital to determine the required rate of return.

Determine the probability distribution of Gandors NPV for each joint venture.
Scenario 1

Year Gross Profit(CHY) Profit for Gandor (50% alocated) EBIT (CHY) Tax Rate Chinese Gov't Tax (CHY) Net Income (CHY) Exchange Rate Net income ($US) CHY1= $.20 Tax rate US Gov't Tax ($) Cash Flow ($) Exchange Rate ($/CHY) Cash Flow ($) Discount Rate PV ($) Initial Investment NPV ($)

1 $ 60,000,000.00 $ 30,000,000.00 $ 30,000,000.00 20% 6000000 24000000 0.20 4,800,000.00 10% 479,999.00 4,320,001.00 0.25 1,080,000.25 17% 3,692,308.55

2 $ 80,000,000.00 $ 40,000,000.00 $ 40,000,000.00 20% 8000000 32000000 0.20 6,400,000.00 10% 639,999.00 5,760,001.00 0.25 1,440,000.25 17% 4,207,758.78

3 $ 100,000,000.00 $ 50,000,000.00 $ 50,000,000.00 20% 10000000 40000000 0.20 8,000,000.00 10% 799,999.00 7,200,001.00 0.25 1,800,000.25 17% 4,495,468.63

$ $ $ $ $ $ 12000000

$ $ $ $ $ $

$ $ $ $ $ $

$ (8,307,691.45) $ (4,099,932.67) $

395,535.96

Scenario 2: Increase in corporate income tax in China

Scenario 2

Year Gross Profit(CHY) Profit for Gandor (50% alocated) EBIT (CHY) Tax Rate Chinese Gov't Tax (CHY) Net Income (CHY) Exchange Rate Net income ($US) CHY1= $.20 Tax rate US Gov't Tax ($) Cash Flow ($) Discount Rate PV ($) Initial Investment NPV ($)

1 $ 60,000,000.00 $ 30,000,000.00 $ 30,000,000.00 40% 12000000 18000000 0.20 3,600,000.00 0% 3,600,000.00 17% 3,076,923.08

2 $ 80,000,000.00 $ 40,000,000.00 $ 40,000,000.00 40% 16000000 24000000 0.20 4,800,000.00 0% 4,800,000.00 17% 3,506,465.04

3 $ 100,000,000.00 $ 50,000,000.00 $ 50,000,000.00 40% 20000000 30000000 0.20 6,000,000.00 0% 6,000,000.00 17% 3,746,223.34

$ $ $ $ $ 12000000

$ $ $ $ $

$ $ $ $ $

$ (8,923,076.92) $ (5,416,611.88) $

(1,670,388.54)

Scenario 3: imposition of a withholding tax by China

Scenario 3

Year Gross Profit(CHY) Profit for Gandor (50% alocated) EBIT (CHY) Tax Rate Chinese Gov't Tax (CHY) Net Income (CHY) Withholding rate Withholding Net Income after Wthholding Exchange Rate$/CHY) Net income ($US) CHY1= $.20 Tax rate US Gov't Tax ($) Cash Flow ($) Discount Rate PV ($) Initial Investment NPV ($)

1 $ 60,000,000.00 $ 30,000,000.00 $ 30,000,000.00 20% 6000000 24000000 10% 2400000 21600000 0.20 4,320,000.00 10% 431,999.00 3,888,001.00 17% 3,323,077.78

2 $ 80,000,000.00 $ 40,000,000.00 $ 40,000,000.00 20% 8000000 32000000 10% 3200000 28800000 0.20 5,760,000.00 10% 575,999.00 5,184,001.00 17% 3,786,982.98

3 $ 100,000,000.00 $ 50,000,000.00 $ 50,000,000.00 20% 10000000 40000000 10% 4000000 36000000 0.20 7,200,000.00 10% 719,999.00 6,480,001.00 17% 4,045,921.83

$ $ $ $ $ 12000000

$ $ $ $ $

$ $ $ $ $

$ (8,676,922.22) $ (4,889,939.24) $

(844,017.41)

The Below probability distribution demonstrates that the NPV will be negative and that there is a 40% chance that the NPV will be negative.

Scenario Original Scenario $ Increase in Chinese corporate income tax $ Imposition of withholding tax by China $

NPV for the scenario 395,535.96 (1,670,388.54) (844,017.41)

Probability that this scenario will occur 60% 20% 20%

NPV calculation $ Possible NPV

=60%(395534)+20%(-1670389)+20%(-844020) 237,320.40 $ (334,077.80) $ (168,804.00) $ (265,561.40)

Would you recommend that Gandor participate in the joint venture? Two items to consider when making the determination on whether Gandor should participate in the joint venture are the NPV for Gandor and the probability of a positive NPV. In this instance as demonstrated in the above three scenarios and the Probability Distribution chart the expected NPV is negative and there is a 40% chance the venture will have a negative NPV. Based on this it is not advisable for Gandor to enter into the project. What would be the key underlying factor that could have the most influence on Chinese profits in the joint venture? I believe that the main influence in profitability would be the Chinese economy. The Chinese economy is continuing to develop and along with development comes the uncertainty of future economic trends and influences (Womack, 1999). Uncertainty would affect demand for the products that would in turn have a negative impact on profits. In addition the above calculations are not exact figures further adding to my view if the uncertainty that lies ahead.

Why would Gandor wish to restructure or revise the composition of its capital when financing a venture like this? As mentioned earlier; the uncertainty in the Chinese economy raises question regarding cash flow. Gandor should consider using more equity. If Gandor uses more equity it could aid in maintaining cash flows to cover debt during the uncertain times.

When Gandor was assessing this proposed joint venture, some of its managers of recommended that Gandor borrow the Chinese currency rather than dollars to obtain some of the necessary capital for its initial investment. Gandors management is considering borrowing Chinese currency in an effort to mitigate their exchange rate risk. Normally this would be a sound consideration that should be fully vetted. However China has a fixed exchange rate and rate risk would not apply in this instance (Chinas exchange rate policy, 2009).

REFERENCES China's exchange-rate policy: AYuan-sided Argument (2009). Why China resists foreign demands to revalue its currency. Retrieved from: http://www.economist.com/node /14921327

Madura, J. (2010). International financial management: (10th ed.). Mason. OH: South-Western, Cengage Learning

Womack, B. (1999). The Asia-Pacific Journal. Vietnam and China in an Era of Economic Uncertainty, Vol. 36-2-09.