OJ Ltd. Is a supplier of leather goods to retailers in the UK and other Western European countries. The company is considering entering into a joint venture with a manufacturer in South America. The two companies will each own 50 per cent of the limited liability company JV(SA) and will share profits equally . £ 450,000 of the initial capital is being provided by OJ Ltd. and the equivalent in South American dollars (SA$) is being provided by the foreign partner. The managers of the joint venture expect the following net operating cash flows, which are in nominal terms:
SA$ 000 Forward Rates of exchange to the £ Sterling
Year 1 4,250 10
Year 2 6,500 15
Year 3 8,350 21
For tax reasons JV(SV) the company to be formed specifically for the joint venture, will be registered in South America.
Ignore taxation in your calculations.
Assuming you are financial adviser retained by OJ Limited to advise on the proposed joint venture.
- Calculate the NPV of the project under the two assumptions explained below. Use a discount rate of 18 per cent for both assumptions.
Assumption 1: The South American country has exchange controls which prohibit the payment of dividends above 50 per cent of the annual cash flows for the first three years of the project. The accumulated balance can be repatriated at the end of the third year.
Assumption 2: The government of the South American country is considering removing exchange controls and restriction on repatriation of profits. If this happens all cash flows will be distributed as dividends to the partner companies at the end of each year.
- Comment briefly on whether or not the joint venture should proceed based solely on these calculations.
Solution
Since only one discounting rate in given and interest rates are absent we have to follow Home currency approach.. Assumption 1: Exchange Control exists.
Decision : Project is not desirable if the exchange control exists
Decision : The project can be picked up is the exchange controls are removed
Also study these questions
- OJ Ltd. Is a supplier of leather goods to retailers in the UK and other Western European countries.
- The rate of inflation in India is 8% per annum and in the U.S.A.
- Trueview plc, a group of companies controlled from the United Kingdom
- Somu Electronics imported goods from Japan
- An automobile company in Gujarat exports its goods to Singapore
