Question Tag: International Investment

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  • 10 Marks

AFM – May 2019 – L3 – Q2b – International investment and financing decisions

Calculate the NPV for a multinational company planning to set up a subsidiary in Ghana and provide a recommendation for management.

A Multinational Company (MNC) is planning to set up a subsidiary company in Ghana (where hitherto it was exporting) in view of growing demand for its product and competition from other MNCs. The initial project cost (consisting of Plant and Machinery including installation) is estimated to be GH¢500 million. The net working capital requirements are estimated at GH¢50 million. The company follows the straight-line method of depreciation. Presently, the company is exporting two million units every year at a unit price of GH¢80, with variable costs per unit being GH¢40.

The Chief Finance Officer has estimated the following operating cost and other data in respect of the proposed project:
i) Variable operating cost will be GH¢20 per unit of production.
ii) Additional cash fixed cost will be GH¢30 million p.a. and the project’s share of allocated fixed cost will be GH¢3 million p.a. based on the principle of ability to share.
iii) Production capacity of the proposed project in Ghana will be 5 million units.
iv) Expected useful life of the proposed plant is five years with no salvage value.
v) Existing working capital investment for production & sale of two million units through exports was GH¢15 million.
vi) Exports of the product in the coming year will decrease to 1.5 million units if the company does not open a subsidiary in Ghana, due to competing MNCs setting up subsidiaries in Ghana.
vii) Applicable corporate income tax rate is 35%.
viii) Required rate of return for such a project is 12%.
ix) Assume that there will be no variations in the exchange rate of the two currencies and all profits will be repatriated, as there will be no withholding tax.

Required:
Calculate the Net Present Value (NPV) of the proposed project in Ghana and advise management.
(10 marks)


NPV = GH¢103.2m

An alternative financial Analysis whether to set up the manufacturing units in Ghana or not may be carried using NPV technique as follows:

  • 8 Marks

AFM – Nov 2018 – L3 – Q2b – International investment and financing decisions

Evaluate the impact of profit repatriation restrictions and provide strategies to deal with blocked funds in international investments.

Suppose the South African government changes its policy on profit repatriation and legislates that profit cannot be repatriated until termination or exit.

i) If Rock can invest blocked funds in South Africa for a 12% annual rate of return, by how much would the project’s NPV differ from your results in sub-question (a) above?
(5 marks)

ii) Suggest THREE (3) ways through which Rock can deal with the risk of blocked funds.
(3 marks)

i) Evaluation of impact of restriction on profit repatriation on the NPV
With a restriction on repatriation until exit, all cash returns from year 3 to the end of year 5 will be available to Rock only at the end of year 5 when it exits. As blocked funds can be invested at 12% in South Africa until the end of year 5, the amount that will be repatriated at the end of year 5 is the aggregate future value of the cash returns from year 3 to year 5.


Change in NPV: The NPV decreases by 3.7% compared to the original NPV of GH¢34.325 million.

ii) Suggestions for dealing with blocked funds
Rock Minerals Ltd can manage the risk of blocked funds by implementing any of the following strategies:

  1. Negotiate with the South African government for a stable profit repatriation policy to avoid restrictions.
  2. Sell goods or services to the subsidiary in South Africa and obtain payment for these services or goods to repatriate funds indirectly.
  3. License the subsidiary to use proprietary production processes protected by patents and receive royalties.
  4. Offer management services to the subsidiary and charge a fee for these services, enabling the transfer of funds.
  5. Increase loan financing rather than equity financing, allowing the subsidiary to repay loans with interest payments instead of relying on profit repatriation.
  • 12 Marks

AFM – Nov 2018 – L3 – Q2a – International investment and financing decisions

Evaluate an international mining investment opportunity in South Africa using NPV approach for financial feasibility.

Rock Minerals Ltd (Rock) is a minerals mining company based in Ghana. Rock is considering an investment opportunity in South Africa, which involves developing and operating a gold mine and later transferring the mine to the South African government.

Last year, the directors commissioned a special committee to assess investments and regulatory requirements relating to the project. Based on the committee’s report, the directors estimate that it will take two years to develop the mine. Development of the mine entails an immediate outlay of ZAR1.2 million in regulatory requirement expenditures, an investment of ZAR20 million in plants and equipment in the first year, and ZAR15 million for development expenditure in the second year. The directors also estimate that Rock will invest ZAR2 million in net working capital at the beginning of the third year. The investment in net working capital is expected to be increased to ZAR3 million at the beginning of the fifth year.

Commercial production and sales are expected to begin in the third year. Below are estimated operating cash flows before tax in the first three years of commercial production:

Year Revenue collections (ZAR’ millions) Variable operating costs (ZAR’ millions) Fixed operating costs (ZAR’ millions)
3 100 40 20
4 150 50 25
5 210 80 30

At the end of the fifth year, Rock will transfer ownership and control of the mine to the South African government for an after-tax consideration of ZAR100 million. The special committee also reports that the income tax rate for mining operations is 30%, and capital expenditure in relation to acquisition of property, plant, and equipment, and development expenditure qualifies for capital allowance at the rate of 20% per annum on a straight-line basis. Capital allowance is granted at the end of each year of commercial production. On repatriation of profit, the committee reports that the South African government does not restrict the repatriation of profit, and there are no profit repatriation taxes. Rock would repatriate cash returns as they become available.

Rock plans to finance this project using existing capital. Rock’s after-tax cost of capital is 25% in Ghana. The annual rate of inflation is expected to be 11% in Ghana and 5% in South Africa in the coming years. Currently, the rate of exchange between the Ghanaian cedi (GH¢) and the South African rand (ZAR) is GH¢0.3822 = ZAR1.

Required:
Evaluate the project on financial grounds using the net present value (NPV) approach and recommend whether the investment proposal should be accepted for implementation or not.
(12 marks)

Evaluation of mining project using NPV with no restriction on repatriation
The project’s NPV

Recommendation:
The positive NPV of GH¢34.325 million suggests that the investment should be accepted as it will enhance the value of Rock Minerals Ltd.

Workings:

  1. Capital Allowance: Capital allowance is granted at 20% per annum on ZAR35 million starting from year 3, resulting in ZAR7 million of annual capital allowance.
  2. Exchange Rate Forecasting: Forecasted exchange rates based on purchasing power parity, assuming inflation rates of 11% in Ghana and 5% in South Africa

 

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