Ace, Inc. a US company has been approached by Lakson Group a company from Pakistan, to explore the possibility of a jo1nt venture in Pakistan to produce widgets. Ace 15 currently exporting l''' widgets a yearto Pakistani importer SS ImportExport Co- at ill-DH Pakistan rupees (PER) each. The spot exchange rate is 100 PER per $1. Each widget costs Ace $3!) to produce and ship to Pakistan. Ace estimates that widget sales in Pakistan will increase at a 5% annual rate; i-e-, salsa will be lili'' widgets next year, 110,250 widgets the year after, etc. Production of widgets in Pakistan requires the construction of a plant which, at the prevailing spot exchange rate, has an immediate cost of $,, to be equally shared by the two rms. The plant could be depreciated on a straightline basis over 3 years. Construction will be completed in one year from now when the current import agreement Ace has obtained from the Pakistani government is scheduled to expire. In addition, it is estimated that at the prevailing spot exchange rate each partner must contribute $5, of net working capital right away to launch the joint venture. The total cost of production in Pakistan is currently estimated to be 231.11.] PER per widget and is expected to remain unchanged over the 15311ng ve years- Part of this cost is for components produced by Ace in the US, at a cost of$5, and then supplied to thejoint venture plant in Pakistan at $1 per widget. SS ImportExport has agreed to buy the widgets produced in Pakistan over the next ve years at the same price it currently pays to import them from the US. The applicable tax rate in Pakistan, and in the US, is 35%- Five years after thejoint venture is established, Ace will pull out and in return it will recover in ll its investment in net working capital and it will also sell its share of the plant to Lakson for an amount equal to 110% of its share ofthe plant's book value at that time. To promote investment by US rms in Pakistan, the US government has agreed that the sale ofAce's share of the plant to Lakson ve years om now has no tax implications- In addition, the Pakistani government has agreed that at the end of each of the rst ve years, Ace may remit its share of the joint ventures net cash ows to the US at the prevailing exchange rate. You are in charge of evaluating the joint venture for Ace. You believe that projects similar to that in the joint venture would require a 12% rate of return if undertaken in the US- Further, your assistant has provided the following input about the projected ination rates over the next ve years: 1. 'What would be your recommendation to Ace? I'u'lake sure you provide calculations using the \"foreign country approach" and the "home country approach" and explain to the management of the two partner rms what the dollar denominated MPH:r of the joint venture to Ace is under each of these two approaches. (Note: To enable comparisons across students please explain 1n detail yourcalculationsfort=2, aswellas foranyspecial, onetime, itemsyou encounteratt= andt 5 1n your analysis.) 2. Assume that: Ace decides to enter in the joint venture. However= Ace has only $1,5, in cash available for investment in the proj ect. Hence Ace wants to get a two year dollar denominated loan now om its US hanlr at 1% annual interest rate against its share ofthe joint venture's rst and second year net cash ows- How much would Ace be able to borrovI.r if it enters in to a forward contract at ll PER per $1? Would the total ofthe loan and the cash currently available enable Ace to proceed with the project?I 3. Assume Ace enters in the joint venture and Bank of Khyber= a Pakistani bank, oEers to remit allflmirenetcashowstoAceatthe xed exchangerate ofll PKRper $1 fora $2,[l fee payable immediately. Would you recommend that Aoe accepts this o'er or not?I
