Prince S.A.: valuation of a cross border joint-venture Assignment

Prince S.A.: valuation of a cross border joint-venture Assignment Words: 1106

Are the financial statements in Exhibit 3. 7 consistent with V. Outran assumptions in Exhibit 3. 1? 2. What’s is the most relevant valuation model, APP or Present Value? 3. How are multi-currency cash flows, currency risk and political risk being taken into account in our valuation model? 4. What is the relevant cost Of capital for Jersey? For R. T. Knack? Can they be different? Why? 5. What is the Diana (Pound) value of the joint venture R. T. Knack (jersey)? What are the project’s value drivers? The data presented on exhibit 3. 7 is, ended following some of the assumptions stated on exhibit 3. 1 : minimum cash level is 10% of total assets, which was proved by dividing cash by total assets, obtaining values between 0. 998 and 1 . Also, dividends would be adjusted in order to debt-to-equity would equal to 1, which also happens in all periods. Exhibit 3. 2 follows some other assumptions: the fabric plant will be upgraded to meet quality requirements, and the upgrade will have costs in the years between 1985 and 1987, including.

Furthermore, the costs relative to three new garment plants are also included in this exhibit. There is a strong usability that these two assumptions may be represented in the behavior of fixed assets on exhibit 3. 7, but since these assets are not discriminated it can’t be certain if exhibit 3. 7 is following both assumptions, or just one. Exhibit 3. 7 does not correspond to the assumption made relatively to constant depreciation, and administrative and selling costs. In exhibit 3. 7 these costs grew, on average, 7. 25% per year. Calculations are stated in Appendix 1. – The Discounted Cash Flow (DOC) and the Adjusted Present Value (APP) are the ;o models that can be used to valuate this project. Under DOC, the Stream of the unleavened free cash flows generated by the project are discounted using WAC, which includes the effects of financing as well as other different sources of risk (such as equity). APP implies that the value of a firm is given by the sum of the discounted unleavened free cash flows as if it was financed only with equity(M theory), and then adds any side effects of debt and sources of risk that may exist.

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This last model is more flexible than DOC. Pap’s power relies on the ability to add relevant factors to the valuation not incorporated on WAC, such as changes in capital structure r even the use of unusual types of debt and equity, like convertible debt. APP is then less prone to serious errors than WAC. In addition, in this model no discount rate contains anything other than time value and a risk premium.

In conclusion, APP should be the method preferred in the case of a cross- border projects because it helps to understand where the value of the project comes from (not only how much is it) and how the value is created and destroyed considering financial maneuvers, currency exchange rate risk and political risk. 3- In the valuation of the project, multi-currency cash flows would not be considered a problem, since the cash flows of the project are first evaluated in the local currency (Diana), then discounted using the appropriate rate and only in the end converted in Pounds using forward rates.

Currency risk is on its own a puzzle that needs to be treated carefully. One can be tempted to consider this risk in the definition of risk premiums or in adjusting the cash flows while this is not the case. In fact, currency risk is already entitled in the forward exchange rates used to convert the expected cash flows while exchange rate volatility is expected to remain under control, s Tunisian Government has incentives to maintain it stable over time in order to further attract foreign investment.

For what concerns political risk, a simple technique will be adopted to adapt the parent (Jersey) cost of capital for political instability in the host country (Tunisia): the long-term bond spread between Tunisian and British government bond (the assumed risk frees) will be added to the initial cost of capital of Jersey. Even if government bond risk- premiums do not fully entangle business risk, they are a good proxy for measuring potential payment complications in the country and government hangers in fiscal and trade policy that would hurt the investment.

The spread thus reflects pretty well the difference perceived by the market between the two countries in terms of political risk. 4-The cost of capital obtained for Jersey is 20. 17% and the cost of capital for Prince is 22. 84%. All the computations elaborated in order to answer this question can be seen on Appendix 1 and 2. These two are different since both companies are facing different levels and types of risk. Although both companies are working together through a joint-venture, risks associated with this project differ for tooth.

Jersey will be investing in a company amidst Mediterranean Rim countries, where it never invested before, and will be facing uncertainty and country-specific risk, such as political or currency risk. Prince will be entering in two new markets: not only the company will start producing garments, where before it only manufactured fabric, but also it will start exporting to Europe, facing an entirely new environment, with new competitors, new currency and new challenges. 5- The approach used to calculate the value of the Joint Venture was a DOC using the APP method. Since the two companies,

Jersey and Prince, have distinct characteristics and costs of capital, they value the project differently. For Prince, the Joint Venture has a total value of 6. 254. 430 Dirham (3. 099. 320 for 50% of the shares), while for Jersey the valuation is considerably higher, 8. 245290 Dirham (4. 122. 650 for 50%). All the assumptions were made based on the financial statements and projections provided on the case. The calculation can be found in the Appendix. One of the project’s main value drivers is the growth rate assumed in the Terminal Value. This perpetuity has a tremendous impact on the total value of the JP or both companies.

The growth rate was assumed to be 8,5%, the Tunisian inflation rate . However, since that this rate can be too optimistic, a sensitivity analysis was performed, in order to measure the impact of variations in this rate. The cost of capital used to discount the project’s cash flows is also an obvious driver of the total value. Since Prince and Jersey have different discount rates, the impact of variations in both costs of capital is also examined in the sensitivity analysis presented. Lastly, the variations in projects value for the different revenues estimates (Low, Medium, High) were also calculated.

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