This week we are studying a joint venture in Brazil, dealing with the
coffee industry. As you probably know, Brazil is a leading coffee
producer.
In order to help guide you through this week’s assignment, see the Wilson Company file posted in the Week 8 Content area.
Answer the questions at the end of the Global Investment case.
Answers should show all calculations and be thoroughly discussed.
Submit the analysis and discussion for Global Investment in one single
Excel file.
GLOBAL INVESTMENT CASE – GIBSON
The second part of this week’s assignment requires you to solve the
problems in the PROBLEM SET posted in the week 8 content area. The
problems are labeled 2016 Aug 23 Week 8 problems JE.
Please include your answers to the problem set in the same file as your answers to the Global Investment Case – Gibson.
Global Investment case
The Gibson Company is a United States (US) firm that is
considering a joint venture with Brasilia, DF, a Brazilian firm that grows and
processes coffee beans.
Gibson has a patent for a new coffee processing method. This
intellectual property is motivating Gibson to expand beyond importing coffee to
engaging in a joint
venture to process the coffee. Gibson will invest $8 million
in the proposed joint venture project, which will help to finance Brasilia ‘s
production using the newly
patented process.
The Brazilian government has guaranteed that the after-tax
profits (denominated in Reals, the Brazilian currency) can be converted to US
dollars at the current
exchange rate and sent to the Gibson Company each year.
Current exchange rates can be found at
http://www.oanda.com.
For each of the first five years, 60 percent of the total
profits will be distributed to Brasilia, while the remaining 40 percent will be
converted to dollars to be sent to
Gibson. The income tax rate for the joint venture will be
10%. However, the Brazilian government is considering raising the income tax
rate to 30%. At the present
time, the Brazilian government doe not impose a separate
income tax on profits sent out of the country. However, the Brazilian
government is considering imposing
an additional 10 percent income tax on profits distributed
to a foreign company. Assume that there are no other forms of tax. After
considering the taxes paid in
Brazil, assume an additional seven percent tax imposed by
the US government on profits received by Gibson Company.
The expected total profits resulting from the joint venture
per year are as follows:
Year Total Profits
from Joint Venture (in BRL)
1 40 million
2 60 million
3 70
million
4 90 million
5 120
million
Gibson’s average cost of debt is 6 percent before taxes. Its
average cost of equity is 9 percent. Assume that Gibson’s US income tax rate is
10 percent.
Gibson’s capital structure is 70 percent debt and 30 percent
equity. Gibson adds between 2 and 5 percentage points to its cost of capital
when deriving
its required rate of return on international joint ventures.
Gibson plans to account for country and other risks within its cash flow
estimates.
Gibson is concerned about country risk in the following two
forms:
(1) Will the Brazilian government increase the corporate
income tax rate from 10 percent to 30 percent (20 percent probability)? If this
occurs,
Gibson
will receive additional tax credits on its US taxes, resulting in no US taxes
on the profits from this joint venture.
(2) Will the Brazilian government impose a separate income
tax of 10 percent on the profits distributed to foreign companies such as
Gibson (20
percent
probability)? If this occurs, Gibson will not receive additional tax credits,
and the company will still be subject to US tax on the profits from
this
joint venture.
Assume that the two types of country risk are mutually
exclusive. If it does anything, the Brazilian government will only implement
one of these changes in its tax policies
(i.e., the increase in the basic income tax on the profits
of the joint venture or the additional income tax on profits distributed to
foreign companies). The Brazilian government
may also choose to leave things as they are.
Assignment
1. Determine Gibson’s cost of capital and required rate of
return for the joint venture in Brazil.
2. Determine the discrete probability distribution of
Gibson’s Net Present Value for this joint venture and calculate the Expected
Net Present Value.
3. Would you recommend that Gibson participate in the joint
venture? Explain.
4. What do you think would be the key underlying factor that
would have the most influence on the profits earned in Brazil as a result of
the joint venture?
5. Under what circumstances might Gibson shift to more
equity financing when considering joint ventures like this? What is the minimum
required return that
would still make
this investment worthwhile?
6. When Gibson was assessing this proposed joint venture,
some of the managers in the company recommended that it borrow the Brazilian
currency rather
than using US
dollars to obtain some of the necessary capital for the initial investment.
They suggested that such a strategy could reduce Gibson’s exchange
rate risk. Do you
agree? Explain.
7. Discuss the benefits of the joint venture from the
perspective of Brasilia. What is the maximum amount of money Brasilia should
invest?
