Trial Exam 1

22 December 2023
Required:
a. In light of the concerns expressed, discuss the decision to use a joint venture as a method of
international expansion.
(8 marks)
b. Produce a report to the Board of Valtick Co., to recommend whether or not to proceed with
the project, which:
i. Evaluates the financial acceptability of the joint venture.
(18 marks)
ii. Evaluate the impact of the existence of the options to sell the joint venture if
Marantitan Co will guarantee to buy Valtick Co’s share of the venture. Assume the
option to sell gives a value of ￡ 95 million.
(4 marks)
iii. Discusses the assumptions made in producing the estimates, and the other risks and
issues which Valtick Co should consider before making the final decision.
(10 marks)

Professional marks for Communication, Analysis & Evaluation, Skepticism and Acumen
(10 marks)
Total: 50 marks
Valtick Co is a company located in Wales that specializes in producing small electronic devices such as digital
clocks. A slump in demand during the last two years has meant that the company has moved into a loss-
making situation and has exhausted most of its cash reserves. Prospects for the future are poor
unless the company can find new markets.

South American joint venture proposal

Valtick Co's managing director has been to South America where she has been discussing a possible joint
venture in Marantinta. A company in Marantinta would like to use the technical expertise and patent rights of
Valtick Co, and set up a manufacturing operation in Marantinta, which would sell clocks to the South
American market, an area to which Valtick Co has never exported. Due to differences in labour costs the
Marantintan company expects to manufacture the clocks for 40% less than it costs to manufacture in Wales.

Some members of the Board of Valtick Co are concerned about the risk of the joint venture and have queried
whether there are other, less risky, methods of international expansion.
Joint venture terms
Under the terms of the joint venture, Valtick Co would be required to:
1. Provide 30% of the total capital of 45 million pesos required to establish production in
Marantinta. 5 million pesos would be for working capital, the remainder for depreciable fixed
assets.
2. Grant full patent rights to produce the clocks in Marantinta. The patent has four years until it
expires.
3. Provide technical expertise to assist in setting up the joint venture.
4. Provide ongoing technical aid.

The joint venture agreement would be for four years. At the end of year 4 the terminal value of
Valtick's share of the Joint venture is currently estimated to be £541,000 (in year 4 prices).

The Marantintan company has agreed that it would not export to Europe within the next four years.
The joint venture agreement would provide for an equal share of future cash flows received from the
joint venture.
Forecast future cash flows arising from the joint venture
The clocks are expected to sell in South America for a price in year 1 of 480 pesos per unit. Prices will then
increase by the expected rate of inflation in Marantinta.

40,000 units are expected to be sold in South America in the first year, rising by 10% per year for the next three
years. The joint venture would also sell an expected 10,000 units per year to the USA at a constant price of $30
per unit.

The provision of initial technical assistance would cost Valtick Co £105,000, which would not be a tax-
allowable expense. The granting of patent rights to the joint venture would mean that the patent could not be
sold to another South American company which was willing to pay a constant £130,000 per year for the patent.

In year 1, direct costs in Marantinta will be 200 pesos per unit, and fixed costs 4 million pesos per annum: both
costs are expected to increase with the inflation rate in Marantinta.

Tax allowable depreciation in Marantinta is available at 50% per year on a reducing balance basis. The tax rate
in Marantinta is 20% and in the UK 30%. A bilateral tax agreement exists between Marantinta and the UK. Tax
is payable one year in arrears.
Cost of capital and risk
Valtick’s cost of capital is 14%, but because of the risk of operating in South America
Valtick’s finance director is proposing to use 18% as the cost of capital for the joint
venture.

The risk-free rate in the UK is 4%.

Expected inflation rates

UK Marantinta US
Year 1-2 3% 20% 5%
Year 3-5 3% 15% 5%

Spot exchange rates

Marantintan Pesos 32.78/ ￡
Marantintan Pesos 18.32/$
Answer
Required:
a. In light of the concerns expressed, discuss the decision to use a joint venture as a method of
international expansion.
(8 marks)
b. Produce a report to the Board of Valtick Co., to recommend whether or not to proceed with
the project, which:
i. Evaluates the financial acceptability of the joint venture.
(18 marks)
ii. Evaluate the impact of the existence of the options to sell the joint venture if
Marantitan Co will guarantee to buy Valtick Co’s share of the venture. Assume the
option to sell gives a value of ￡ 95 million.
(4 marks)
iii. Discusses the assumptions made in producing the estimates, and the other risks and
issues which Valtick Co should consider before making the final decision.
(10 marks)

Professional marks for Communication, Analysis & Evaluation, Skepticism and Acumen
(10 marks)
Total: 50 marks
a. In light of the concerns expressed, discuss the decision to use a joint venture as a method of international
expansion.
(8 marks)
Points Marks

Aims of Valtick’s objective – prolong the lifecycle of its electronic products. 1

International (slump in demand, loss making, poor future prospect unless go
expansion international)

Advantage JV • Sharing of cost and risk – Advantage for Valtick (due to low 3 ( 1 for each
cash reserve and loss making; see para 1) because setting up point with
a business oversea is costly and risky – JV allows for cost justification)
sharing and risk can be reduced since the JV partner is a local
firm (familiarity, credibility, acceptability etc)
• JV partner has knowledge and expertise regarding its
country and market – can deal with cultural clash, access to
efficient distribution, skills, preferred method of doing business
etc
• JV makes the entry to international market easier.
Governemnt incentives (partner with local partner)
Points Marks

Disadvantage JV • JV more difficult to manage in comparisons to direct 4 ( 1 for

investment oversea (loss of control – labor, supplier, quality, each point
work culture and ethics etc) with
• Risk of technology transfer – enabling them to set up justification)
independently. (How to overcome? Patent and copyright; but
some times cannot be enforceable locally) 🡪 can become a
threat to Valtick ( JV partner enter European market to compete Skepticism
with Valtick) Acumen
• Default or nonfulfill commitment; non payments at the end of
four year agreement (see scenario, Terminal value of ￡ 341)
• Threat to seizing of asset from the foreign government
(political risk)
Skepticism 1

Acumen 1
Required:
b. Produce a report to the Board of Valtick Co., to recommend whether or not to proceed with
the project, which:
i. Evaluates the financial acceptability of the joint venture.
(18 marks)
ii. Evaluate the impact of the existence of the options to sell the joint venture if
Marantitan Co will guarantee to buy Valtick Co’s share of the venture. Assume the
option to sell gives a value of ￡ 95 million.
(4 marks)
iii. Discusses the assumptions made in producing the estimates, and the other risks and
issues which Valtick Co should consider before making the final decision.
(10 marks)

Professional marks for Communication, Analysis & Evaluation, Skepticism and Acumen
(10 marks)
Total: 50 marks
Points Marks

Intro The purpose of the report is to evaluate whether or not Valtick should 1
State the purpose participate in the JV in Marantinta. This report will discuss the financial
(refer to the acceptability of the joint venture, and other factors considered to be
requirement) relevant to the decision.

Assume that the share of 50% profit is remitted to UK annually, the

method used is to convert Valtick’s share of the foreign cash flow to
sterling and to discount these cash flow using a suitable cost of
capital. The detailed calculation is shown in the appendices to this
report.
Evaluates the From the estimate made (see Appendix 1), the net present value is 1
financial approximately negative ￡ 70,000, indicating that the investment is
acceptability of the not worthwhile because it does not give the required 18% return. Analysis -
joint venture.
(Use Appendix 1 as However, there may be scope to increase Valtick’s share of the cash 1
reference point) flow from 50%, which might make the project viable.
Points Marks

Evaluate the The right to sell the operation in four year’s time is a put option. 2
impact of the Taken into consideration this put option value of ￡ 95 million gives
options to sell the the overall NPV of the project a small positive value of ￡ 25 Analysis – 1
joint venture to million (-70+95 million), which make the project marginally
Marantitan Co financially viable.
that gives a value
of ￡ 95 million. If there is changes in the market condition that caused a change in 2
(4 marks) the assumptions made in the project, the estimated NPV may be Acumen - 1
affected. For example, if the South African government withhold the
remittable dividend, the project may be non-financially viable.
Points Marks

Discusses the Assumptions 2

assumptions and Sales rev, cost, royalties, initial investment, WC, inflation, are
the other risks accurate – There is uncertainty surrounding the accuracy of these Skepticism -
and issues which variables and a small change in them could change the forecast of 1
Valtick Co should the project quite considerably. A sensitivity and scenario analysis
consider before may aid in the decision making process
making the final
decision. Future exchange rate is assumed to reflect the differential in 2
(10 marks) inflation rates between respective countries. However, it is unlikely Acumen/
that the exchange rate will move fully in line with the inflation rates practical – 1
differential as has been forecast because many factors like political
shock, change in economic condition may influence the exchange
rates.

The basis of using 18% cost of capital is not clear. No explanation 2

provided about whether it is an accurate figure and already taken Skepticism-1
into consideration risk of new market. The underpinning basis of Acumen/
how it was determined requires further investigation. practical - 1
Points Marks

Discusses the Other risk and issues

assumptions and Investing in Marantinta may result in significant political risks. 2
the other risks Valtick need to assess how likely is that the government may Skepticism -
and issues which change during the time it is operating in SA and the impact of the 1
Valtick Co should change. Valtick shouls assess the likelihood of changes in tax
consider before rates, laws and regulations and to consider strategies to mitigate
making the final those risk.
decision.
(10 marks) The financial projections are prepared on the basis that positive
cash flows from the JV can be remitted back to the UK. Valtick 2
need to establish that this is indeed the case and that it is likely to
continue in the future.

Valtick should also consider its ethical stance and impact on its
reputation of its JV operations in Marantinta.

Valtick should consider the JV to supply to other markets like Asia

or Europe.
Points Marks

Discusses the Recommendation

assumptions and 2
the other risks
and issues which
Valtick Co should
consider before
making the final
decision.
(10 marks)

Communication – Flow and format 2