Question
Twine SA, a mining company based in Mexico, has contacted Dynatrade plc, a company based in the UK, proposing a four-year joint venture to mine
Twine SA, a mining company based in Mexico, has contacted Dynatrade plc, a company based in the UK, proposing a four-year joint venture to mine copper using a new technique developed by Dynatrade. Dynatrade would supply machinery at a cost of 800 million pesos, and 10 supervisors at an annual salary of 40 000 each at current rates. In addition, Dynatrade would also pay half of the 1 000 million pesos per year (at current rates) local labour costs and other expenses. Salaries for supervisors and local labour and other expenses will be increased in line with inflation in the UK and Mexico respectively. Inflation in Mexico is currently 100% per year while that in the UK is 8% per year. The Mexican government has put in place measures that it hopes will reduce inflation each year by 20% of the previous years inflation rate. The current exchange rate is 140 pesos per pound and future exchange rates may be estimated using the purchasing power parity theory. The terms of the joint venture entitle Dynatrade to a 50% share of Twines copper production, with current market prices pegged at 1 500 per 1000 kilogrammes. Twines production is expected to be10 million kilogrammes per year, and copper prices are expected to rise by 10% per year (in pounds) for the foreseeable future. At the end of four years Dynatrade would be given the choice to pull out of the venture or to negotiate another four-year joint venture, on different terms. Dynatrades cost of capital for its UK mining operations is 16% per year but it considers a 2% reduction in the cost of capital for this venture to be appropriate due to diversification effects. Corporate tax is 20% per year in Mexico while in the UK it is 35% per year, paid one year in arrears in both cases. A tax treaty exists between the two countries, and all foreign tax paid is allowable against any UK tax liability. A 25% straight-line writing-down allowance is available on the machinery in both countries. Cash flows may be assumed to occur at the year end, except for the immediate cost of machinery. The machinery is expected to have a negligible terminal value at the end of four years.
Required Calculate the projects NPV and decide whether Dynatrade should accept it or not. State all assumptions that you make.
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