Scenario
Sodoria is a small country located on the coast of Africa, whose main economic activity is agriculture. The country has faced difficult economic challenges over the past two decades as a result of some questionable economic policies and political decisions made by previous governments. Foreign direct investment in Sodoria declined as a result of the global crisis and subsequent internal political upheaval. The political instability has lessened since a new, democratically elected government took office two years ago, which imposed strict financial policies and legislative controls to try to bring the country out of its difficulties. As a result, the annual rate of inflation has fallen rapidly from a high of 65% to its current (2015) level of 35%. The Sodorian Government anticipates that the annual inflation rate will continue to fall over the next few years. The Government is keen to continue the progress made so far by encouraging foreign direct investment into the country, and foreign companies are beginning to explore the natural resources of Sodoria with a view to potential investment.
The senior management of a UK company, Zinto plc (‘Zinto’) has for some years been interested in Sodoria as a possible location for investment. Zinto is a large international copper processing company with business activities in various countries. Zinto had been considering setting up its own operation in Sodoria, but has recently been approached by another company with a proposal for a joint venture. The other party in the proposed joint venture is Milton Co (‘Milton’), a company based in Sodoria. Milton has already carried out a relatively small-scale project to explore the rich copper deposits that are known to exist on the northern part of Sodoria, following a recent geological survey. Milton expects that the copper deposits will be worth mining for at least the next 12 years. One of the directors of Milton, who has previously worked with a senior member of the Sodorian Government, has recently managed to negotiate a government agreement that grants Milton exclusive rights to mine the copper, with a suitable joint venture partner if required.
The area of land where the copper deposits are located is currently occupied by subsistence farmers, who would have to be relocated to other parts of the country if the project goes ahead. Milton has already identified potential relocation sites and will pay for the costs of the relocation and compensation to the farmers. The Sodorian Government has also offered to contribute to part of this cost as it wishes to encourage economic development in that part of the country.
The copper would be mined using a new, efficient method developed by Zinto. In addition to technical expertise, Zinto will supply machinery for the venture at a cost of 1,350 million Sodorian Riand (the Sodorian currency, SR). Zinto would also provide 15 appropriately qualified managerial staff to supervise the mining operations. These managers will have an average annual salary of £55,000 in terms of today’s prices. Under the terms of the joint venture, Zinto’s share of the copper produced would be 45%. Zinto would also pay a share of the local labour costs and other expenses in Sodoria, which total an estimated SR2,900m in today’s prices. It is anticipated that Zinto’s contribution of technical expertise will be greatest in the first two years of the project. On this basis, the parties have agreed that Zinto’s share of the local labour costs and other expenses will be 35% in the first year, 40% in the second, and 45% thereafter. The managers’ salaries, local labour costs, and other expenses will increase over time as a result of inflation in the United Kingdom and Sodoria respectively.
Milton has stated that it is willing to buy out Zinto’s share of the venture at the end of the six year period. At present Milton has suggested that a price of SR7,000 million would be reasonable, but have stated that a firm commitment to this amount cannot be made until a later point in time. Alternatively it may be possible to renegotiate a further joint venture at the end of the six years.
Zinto has ascertained the following forecasted relevant information:
2016
2017
2018
2019
2020
2021
2022
Estimated annual copper production, million kg
8.5
9.8
11
11
11
11
11
Forecast copper price,
$ per metric ton
5,956
6,064
6,174
6,285
6,399
6,515
6,633
Sodorian corporation tax rate
15%
15%
30%
30%
30%
30%
30%
UK corporation tax rate
20%
19%
19%
19%
18%
18%
18%
Annual inflation rate, Sodoria
24.50%
17.00%
12.00%
10.00%
10.00%
10.00%
10.00%
Annual inflation rate, UK
1.60%
2.00%
2.00%
2.00%
2.00%
2.00%
2.00%
Annual inflation rate, US
1.80%
1.90%
1.90%
1.90%
1.90%
1.90%
1.90%
Assume it is now the end of 2015. If the joint venture goes ahead, it will commence at the beginning of 2016. Cash flows may be assumed to occur at the year end, except for the immediate cost of machinery.
Taxation is payable one year in arrears and a 10% straight line writing down allowance is available on the machinery. The machinery is expected to have negligible terminal value at the end of ten years.
Zinto’s weighted average cost of capital is estimated to be 17%. If the joint venture goes ahead, it will not change the company’s overall business risk significantly. A
tax treaty exists between the two countries and foreign tax paid is allowable against any UK tax liability.
The current exchange rate is £1 = SR76. Zinto believes that future exchange rates may be estimated using purchasing power parity theory.
Required
Assess whether Zinto plc should undertake the joint venture project. Your work should include the following:
(a) An evaluation of the potential advantages and disadvantages to Zinto plc of entering into a joint venture as opposed to setting up business independently in Sodoria. (10 per cent)
(b) A numerical analysis using a discounted cash flow approach and based on the information provided to indicate whether the joint venture will be worthwhile for Zinto. You should state clearly any additional assumptions that you feel are necessary. (35 per cent)
(c) A consideration of the key risk factors that are relevant to the decision whether to undertake the investment, with suggestions on how these risks might be managed. (30 per cent)
(d) A summary and overall recommendation as to whether Zinto plc should go ahead with the proposed joint venture. You should include discussion of the limitations of your analysis in part (b) and your answers to parts (a) and (c), and any further factors that you consider to be relevant. (15 per cent)

Place your order now for a similar paper and have exceptional work written by our team of experts to guarantee you A Results

Why Choose US

6+ years experience on custom writing
80% Return Client
Urgent 2 Hrs Delivery
Your Privacy Guaranteed
Unlimited Free Revisions