INTERNATIONAL CORPORATE FINANCE
Teck systems Inc., a Texas-based manufacturer of computer equipment, is considering the establishment of a manufacturing plant in Zana, a small West African country with a population of about 29.6 million. The countrys currency is the Cedi and it is traded against most foreign currencies including the U.S. dollar. The exchange rate between the Cedi and the U.S. dollar is quoted in the forex market as:
U.S. $1 = ZC5.50
The financial team of Teck Systems Inc. has gathered that Zana is a democratic country with stable economic, social, and political environments. Although, the value of the Cedi in the foreign exchange market has remained stable for the past three years, next years projection depicts an unfavorable economic situation because of the Covid-19 pandemic and its adverse effect on emerging economies. A quick internet research on Zana shows that the projected budget deficits, interest rate, inflation, and trade deficits may deteriorate and cause a gradual depreciation of the Cedi against the U.S. dollar. Inflation is expected to increase from 6% to 9%, unemployment rate is expected to increase as well. The increase in unemployment rate is likely to lead to political unrests and less demand for goods and services. The results of the google search on Zana are shown below:
Please see attachment
*FDI refers to foreign direct investment
Rule of law: Zanas secured interest in property rights is recognized and enforced, although the process of getting clear title over land and other property is difficult, complicated, and lengthy. There is bribery and corruption in the judicial system and the government has some power and control over the judiciary and the legislature.
Government size & tax rates: The top personal and corporate income tax rate is 35%. Other taxes include value-added, property, and capital gain taxes. The overall government spending is 25% of GDP, a rise of 2.7%. The government spending is 70% of revenue and 25% of the revenue is spent on financing foreign loans.
Regulatory efficiency: Some progress has been made in enabling business environment, but financial services, electricity, and water supply remain expensive. The cost of doing business in Zana is expensive although the government supports foreign companies and gives them incentives.
Open markets: Zana is open to foreign markets and trades with countries in Americas, Asia, Europe and other African countries. The World Bank and IMF assign a credit rating of B+ to Zana because if its future excellent prospects. The total value of exports of goods and services equals 73.6% of GDP, an increase of 3.0%.
Per the agreement with the Zanaian government, the project will be transferred to a local private entrepreneur at the end of 10 years. The financial management team of Teck Systems has estimated the cost of the project to be US$10 million.
The Board of Teck Systems needs your technical input to decide whether to enter the Zanaian market or not.
1. Based on the exchange rate between the Cedi and the U.S. dollar, what is the cost of the project in Zanaian Cedis?
2. According to the theory of relative purchasing power parity, if inflation in Zana is predicted to be 9% over the next three years whereas the U.S. inflation rate will be 3%, what will be the exchange rate in three years?
3. Based on the answer to question b above, the finance team wants to know whether the cedi will depreciate or appreciate. (Choose one: depreciate or appreciate) and why?
4. Suppose the exchange rate for Zanaian Cedi is currently ZC5.50 = US$1.00. If the interest rate in the United States is 5% and the interest rate in Zana is 10%, according to the interest rate parity, what must be the forward rate to prevent covered interest arbitrage?
5. The shareholders of Teck Systems Inc. want to know the benefits of doing international business in emerging economy like Zana. List four advantages that can convince the shareholders of Teck Systems to accept the project in Zana.
6. The shareholders also want to know some of the risks associated with doing business in emerging economies like Zana. Explain three risks Teck Systems Inc. is likely to face if it goes ahead with the project in Zana?
7. If the rate of return is estimated to be 16% per year on the project, and the Cedi is expected to depreciate by 10% against the U.S. dollar (ZC6.05 = US$1) in 10 years,
i. what will be the ending value of the project in Cedis?
ii. translate the ending value into U.S. dollars,
iii. compute the compounded rate of return per year on this investment in dollar terms to shareholders of Teck Systems Inc.
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