4 Kay plc, a UK-based chemical firm but with plants in Germany and the Netherlands, manufactures man-made fibres. It would like to expand its exports to Latin America and the country of Copacabana, in particular.

However, Copacabana is unable to pay in Western currency and its own currency, the poncho, is subject to rapid depreciation, due to high local inflation. One solution to this problem is an arrangement whereby Kay manages and pays for the construction of a fibres plant and accepts payment in the form of the finished product of fibres (a so-called buyback).

Construction will take two years and expenditures can be treated as four equal half-yearly payments of 10 million ponchos at today’s prices, beginning in six months’ time. The plant will have a 15-year life, but will attract no local investment incentives. The inflation rate in Copacabana is expected to average 20 per cent p.a.

over the construction period. The current exchange rate of the poncho vs. sterling is 1:4 and inflation in the UK has recently averaged 5 per cent.

The fibres produced and taken as payment can be traded on world markets, probably in Europe, where the present price is ;500 per tonne. Kay is not prepared to accept payment in this way for more than five years. The expected production rate of the plant is 20,000 tonnes per annum, and Kay would take 40 per cent of this in payment.

The current euro vs. sterling rate is ;1.60 per £1, and sterling is expected to depreciate by 5 per cent per annum prior to joining the euro bloc.

Further information

■ The project will be financed by equity only.

■ Kay is at present debt-free. Its shareholders seek a return of 20 per cent p.a. for projects of this degree of risk.

■ Profits from the operation will be taxed at 30 per cent when repatriated to the UK. Assume no delay in tax payment. All development costs will qualify for UK tax relief.

■ Any losses will be carried forward to qualify for tax relief.

■ There will be no tax liability in Copacabana.

Required Determine whether Kay should undertake this project.