3 Would you recommend that Gandor participate in the joint venture? Explain. Gandor plc is a UK...

3 Would you recommend that Gandor participate in the joint venture? Explain.

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Gandor plc is a UK firm that is considering a joint venture with a Chinese firm to produce and sell videocas- settes. Gandor will invest 12 million in this project, which will help to finance the Chinese firm's produc- tion. For each of the first three years, 50% of the total profits will be distributed to the Chinese firm, while the remaining 50% will be converted to dollars to be sent to the United Kingdom. The Chinese government intends to impose a 20% income tax on the profits distributed to Gandor. The Chinese government has guaranteed that the after-tax profits (denominated in yuan, the Chinese currency) can be converted to Brit- ish pounds at an exchange rate of 0.13 per yuan and sent to Gandor plc each year. At the current time, no withholding tax is imposed on profits sent to the United Kingdom as a result of joint ventures in China. Assume that after considering the taxes paid in China, an additional 10% tax is imposed by the UK govern- ment on profits received by Gandor plc. After the first three years, all profits earned are allocated to the Chinese firm. The expected total profits resulting from the joint venture per year are as follows: Year 1 2 3 Total profits from joint venture (in yuan) 60 million 80 million 100 million Gandor's average cost of debt is 13.8% before taxes. Its average cost of equity is 18%. Assume that the cor- porate income tax rate imposed on Gandor is normally 30%. Gandor uses a capital structure composed of 60% debt and 40% equity. Gandor automatically adds 4 percentage points to its cost of capital when deriving its required rate of return on international joint ventures. Though this project has particular forms of country risk that are unique, Gandor plans to account for these forms of risk within its estimation of cash flows.