International investment - Treasury, foreign exchange and trade finance

I. Introduction

To answer this question I will evaluate various possible scenarios, taking into con- sideration various environmental factors that effect international investment projects. The result will not be 100% certain, but will give an indication of how high the risks are and whether or not they are worth taking.

II. Assumptions

To begin with a few assumptions have been made which remain true for all of the following scenarios. o Firstly that the French government allows a tax credit upon all taxes paid in Emergia. Further it assumes that the Emergian government will not levy a withholding tax on funds remitted to France. These assumptions have been made due to lack of information to the to simplify the analysis and make it more comparable. Should these not hold then all scenarios evaluated here would have to be adjusted for these points.

- Volumes remain stable. This is in order to allow for a conservative evaluation across all models. There is not enough information given to evaluate the pro- spective market, other than the fact that it is stable. Theoretically a stronger Ziloti would reduce the cost of imported material, possibly allowing for prices to be reduced and thus increase volume whilst also increasing or at least maintaining margins, however such volume effects will not be included here.
- Inflation and interest rates have been given as fairly reliable and they will therefore also remain constant throughout the scenarios. However they will both be used to attempt to determine future exchange rates at a later stage.
- The salvage value of the plant is a very important cash item. However the of- fer being made by the Emergian government means that this value will be zero by the time the project closes. This item remains cash ineffective throughout all scenarios, due to the fact that project life and useful life for depreciation purposes match each other precisely.
- The low local tax rate of 20% could be changed. But will be assumed as be- ing stable for simplicity and as there are no indications that Emergia wishes to drive FDI out of the country at present.

Factors which will vary are as follows:

- Exchange rates. Due to the pegging of the Ziloti to the US Dollar and the cur- rent appreciation of the same it becomes probable that the currency peg could be loosened or removed completely. This could occur because the high dollar could have a negative effect upon the Emergian economy through making the currency too expensive versus the Euro (cross exchange rate) and thus drive investment out of the country. Both scenarios are plausible - a loosen- ing of the peg would probably cause the currency to depreciate versus the Euro whereas maintaining the peg could the cause the currency to increase in value. Both situations need evaluating. Exchange rates can be forecasted us- ing Purchasing Power Parity or the International Fisher Effect methods.
- The flow of funds policy of the government is also another item which will be treated as a variable. Currently the country blocks funds from the invest- ment until the end of the project life, with major effects upon the present value of the project. This item could possibly be lifted by the government if the company could persuade them as such and therefore alternatives will be looked at. Blocked funds would not be a problem if the project were set up long term, as the monies could be maintained within the company and used for further expansion and growth. However as the time line runs over five years it becomes is an important issue.
- The Government allows blocked funds to currently be reinvested locally at a specific interest rate (12%) until remittance occurs. This is also a policy which a government could also change and which will therefore also be accounted for.
- The impact of the proposed investment on existing cash flows is also an issue that will be taken into consideration. The current export business ( I assume here it is already running in 2001) will be lost should investment be made, however there are certain environmental factors which can cause this to be evaluated in an alternative way.

III. Scenarios with Stable Exchange Rates

Predicting the market development of exchange rates is very tricky and fallible. Therefore the following will run through various scenarios assuming stable exchange rates in order to more accurately hone in on the optimal investment cond itions ( It is not said that the Emergian Government will not be open to make concessions for an attractive foreign investor). The most appropriate case will then be subjected to varying exchange rates in the next section.

Scenario 1 - Blocking of funds at 12 % interest

Appendix 1 has a calculation showing the cash flow of the new plant according to the current situation. The model is self explanatory up to point 12.

Point 12 shows the investment in working capital being turned into a local currency item at the begin of operations. Further no change in working capital is assumed due to the constant volumes and the effects of inflation on both sides of the balance sheet. By closure the working capital investment turns positive as it is bought off by Emer- gian investors.

Point 13 shows the interest being earned on the invested funds and assumes that the interest earned is reinvested and thus - in turn - earns further interest. The cumulative interest earned grows steadily as all monies are reinvested year on year until repatria- tion of funds can occur. This effect in itself earns the company a positive cash flow as the investment interest rate of 12% being equal to the companies weighted average cost of capital. Thus current blocking of funds has a positive effect upon the valua- tion of the proposed investment. This could be different, although, if the interest rate changes.

Point 15 shows the cash flows arising from holding company sales to the new plant. These cash flows have the advantage that they are free of currency risk as denominated in Euro and are therefore currency risk free.

These form the basis for the scenario 1. This scenario shows the project throwing off a positive cash flow with a Net Present Value of 786.419€. According to this base case the investment should be made.

However a major issue has not been accounted for and that is the effect of the new plant on the current export activities. Appendix 2 details this effect - amongst other things.

The top section of Appendix 2 shows the undiscounted cash flows currently being earned through export activities. (Total cash flow 720.000€). This will be lost should the plant be built and therefore the lost cash must offset the potential new gains. This can be seen in Scenario 1 a bit further down the page. In the end a Net Present Value of 205.041 € remains. Positive indeed but less so than originally projected.

Scenario 2 - Blocking of funds at 0 % interest

Appendix 3 (point 13) assumes that the government decides not to allow the nonremittable cash flows to be reinvested and earn interest.

The consequence is summarized in Appendix 2, showing that this would cause the project to become unprofitable with a negative Net Present Value of 175.231 €. This highlights the importance of the need to keep a close eye upon local interest rates as long as Emergia continues to block funds.

Scenario 3 - No blocking of funds

Appendix 4 shows the base calculation assuming that the blocking of funds is lifted by the government. In this scenario funds are directly remitted as soon as the cash flow allows for positive funds to be transferred. Due to the time value of money effect this naturally makes the investment more profitable with a positive NPV of 598.793€.

However, taking reference to Appendix 2 again it can be seen that the lifting of the funds blocking is not as valuable as scenario 1 as it only produces + 17.415 €.

One can therefore ascertain that the current situation is highly profitable for the company.

Scenario 4 - No blocking of funds

Finally in this section the view could be taken, as shown in Appendix 2 - Scenario 4 that there is no cash flow forgone.

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