OJ Limited is a supplier of leather goods to retailers in the United Kingdom 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. Of the initial capital, £450,000 is being provided by OJ Limited, 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 Predicted future rates of exchange to £ sterling Year 1 Year 2 Year 3 4,250 6,500 8,350 10 15 21 For tax reasons, JV (SA), the company to be formed specifically for the joint venture, will be registered in South America.

Ignore taxation in your calculations.

Assume you are a financial adviser retained by OJ Limited to advise on the proposed joint venture.

Required

(a) Calculate the NPV of the project under the two assumptions explained below. Use a discount rate of 16 per cent for both assumptions, and express your answer in sterling.

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 restrictions 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.

(b) Comment briefly on whether or not the joint venture should proceed based solely on these calculations.

(CIMA)