597
the 5% royalty on net sales. The interest on the bank loan is computed on
a loan balance of 20m in January 2000 and 2001, 16m in January 2002,
12m in January 2003, 8m in January 2004, and 4m in January 2005.
Interest is payable in four quarterly tranches (2% effective per quarter).
- Taxable profit is the annual profit minus any tax shield from carried-over
losses. Taxes (40%) are payable in the middle of the year following the
reporting year; that is, taxes on 1994 profits are paid mid-1995 etc.
On the flight back to Belgium, Mr Dondeyn types the projectedP/Lstatement
into his laptop, and runs a quick-and-dirtyNPV. To compute the cash flows, Mr
Dondeyn notes that the net investment is zero (total investments are entirely fi-
nanced by a loan); so he takes profits after taxes, adds back depreciation and sub-
tracts the loan amortizations. The cost of capital is set at 14% (the 8% on the loan
being the subsidized rate at which theJVwould be able to borrow, plus a 6% risk
premium assuming a unit beta). TheNPVseems to be –0.71m rupee—not hugely
negative, but negative nevertheless.
Issues
- TheNPVcalculations do not seem to involve anything special: it all looks like
domestic capital budgeting. Are there no special issues that arise when the
project is international?
- The quick-and-dirty calculation ascribed to Mr Dondeyn ignores the fact that
there are two shareholders, and is made as if this were a wholly-owned project.
Even so, these calculations are very flawed: I stuffed about every mistake into
the spreadsheet one could possibly make. Read this part, identify the errors,
and correct them.
- Is there a way to judge the fairness of the proposed cash-splitting rules for the
JV? What should one look at? If one finds a good measure of fairness, is there
a straightforward way of achieving this fairness, or is it just a matter of trial
and error?
