The Examiner's Answers – F3 - Financial Strategy Nov 2011

The Examiner's Answers – F3 - Financial Strategy Some of the answers that follow are fuller and more comprehensive than would be expected from a well-prepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike.

SECTION A Answer to Question One

(a) Three alternative uses of the funds have already been suggested by the Board of the Newspaper Division. These are: • • •

Reinvest in a new project.

Repay debt.

Pay a one-off dividend.

Investments, funding and dividend decisions are the main financial decisions facing all companies and are closely interrelated as each decision affects the others.

Reinvest in a new project Reinvestment of the funds into a new project that has a positive NPV would help M plc achieve its growth targets as stated in its financial objectives. As we know from the pre-seen material, the key shareholders (that is, the bank, charity and financial institution) are putting pressure on the Board to devise a strategic plan aimed at achieving M plc’s stated financial objectives.

Growth in revenue and profits between 2011 and 2012 met profit growth targets but not revenue growth targets as the following analysis shows:

Revenue Operating profit

2011

2012

274 68

200 73

Growth achieved 2.2% 7.3%

Target growth per financial objectives 4.0% 4.0%

A company such as M plc is likely to have a wide range of projects with positive NPVs to consider. These need to be assessed as to their contribution towards meeting M plc’s financial and strategic objectives.

With the disposal of FR, M plc will lose control over the pan European newspaper that FR produces and which helps to meet one of its strategic objectives (strategic objective number 3). M plc may therefore wish to consider whether it is possible to provide a news service to native English speakers over a wide geographical spread (strategic objective number 2) by

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some other means and evaluate projects that might help meet those objectives. For example, M plc could consider launching a web version to reach this readership group.

Reduce debt levels We know from the pre-seen material that £83 million of loan capital is due for repayment on 1 April 2013, that is, in 16 months’ time. The sale proceeds could therefore be retained and invested for use in repaying the loan capital at that time or at an earlier date if early redemption is allowed without penalty.

Alternatively, other debt could be repaid now and separate arrangements made to repay the loan capital of £83 million due in 16 months.

The current gearing level of M plc based on the latest forecast statement of financial position is 33.8%. This is reasonably comfortably within the gearing target of 40% and so there is no urgent need to repay debt in order to keep within the gearing target.

Workings: Market capitalisation is GBP 490.00 million = 140 x GBP 3.50.

So gearing (D/D+E) is currently 33.8%, ( 0.338 = GBP 250/(250 + 490).

If the full value of the anticipated proceeds of EUR 75 million were to be used to repay debt, and assuming M plc’s share price were to remain unchanged at £3.50, M plc’s gearing level would fall to 27.2%. However, this would reduce shareholder returns due to loss of tax relief on debt interest and heavier reliance on more expensive equity capital.

Workings: New gearing (D/D+E) = 0.272 = (250.00 – 66.75)/(250.00 – 66.75 + 490.00) where 66.75 = 75 x 0.8900 Note that all these calculations assume no change in the share price as a result of changes in gearing. This is unlikely in practice due to changes in risk and return required to debt and equity holders arising from a change in gearing.

Another important consideration is the likely success of rollover negotiations regarding the borrowings due for repayment in a year’s time. If the company is considered to be likely to face refinancing risk, the sales proceeds should be retained to help meet the forthcoming debt repayment.

Pay one-off dividend At first sight, this may appear to be an attractive option from the point of view of the shareholders, providing an immediate cash benefit. However, this is only a short term view and is likely to lead to comparatively lower shareholder wealth over the longer term due to the higher cost of capital that would result (as discussed above).

A one-off dividend would only be beneficial to shareholders in the longer term if the funds can be invested at higher returns by the sharehodlers than by the company. Funds should only be returned to shareholders if they cannot be reinvested in the business to produce a higher return than the shareholders could create themselves. Indeed, one-off dividend might send a signal to the market that there are no profitable investment opportunities available and hence the share price could actually fall.

An added risk is that paying a one-off dividend may create an expectation that dividends will also be higher in the future. This would create problems in the future if M plc is not be in a position to satisfy such expectations.

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Conclusion In this scenario, the highest priority would appear to be to reinvest in positive NPV projects in order to boost future earnings streams.

(b) (i) PP's bond cost of debt Time MV Net interest (6% x (1 – 0.70) Redemption

0

CF EUR -103.00

DF 5% 1

1 to 3 3

4.20 100.00

2.723 0.864

PV -103.00

DF 3% 1

-103.00

11.44 86.40

2.829 0.915

11.88 91.50

-5.16 So the current post tax cost of the bond is 3.1%

PV

0.38

( = 3% + 2% x (0.38/(5.16 + 0.38)))

Examiner’s note: A calculation based on market values is equally acceptable and produces the same result.

C

Bond Preference shares Ordinary shares

cost of capital 3.10% 5.93% 10.50%

So WACC is

8.143%

MV C x MV value (EUR m) 123.6 3.83 W3 27.0 1.60 W4, W5 290.0 30.45 W1, W2 440.6 35.88 ( = 35.88/440.6 x 100%)

Workings W1 Cost of equity is 3% + 1.5 x 5% = 10.5% W2 Market capitalisation is 50 million x EUR 5.80 = EUR 290.0 million W3 MV of bonds is 120 million x EUR 103/100 = EUR 123.6 million W4 Cost of preference shares is EUR 8.0/EUR 135 x 100% = 5.93% W5 MV of preference shares is EUR 1.35 x 20.0 million shares = EUR 27.0 million shares Valuation of FR Net assets Non current assets Net current assets Value

EUR million 56 2 58

Note: no deduction for debt is necessary as the net assets of FR are being acquired, free of debt.

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Earnings valuation based on P/E Using M's P/E ratio: Equity: EUR 44.6m Total value: EUR 69.6m

= 4 x 11.14 Using M's P/E of 11.14 (= 3.50 x 140/44) after adding debt of EUR 25 million to obtain the combined debt plus equity value of FR

Using PP's P/E ratio: Equity: EUR 52.0m Total value: EUR 77.0m

= 4 x 13 Using PP's P/E of 13 given in the question after adding debt of EUR 25 million

DCF of pre-interest and post-tax free cash flows at WACC Free cash flow (FCF) is: Earnings Add back finance charge Deduct tax relief on finance charge (at 30% of 1.4) Add back depreciation Deduct funds reinvested FCF pre-financing cash flows

EUR million 4.0 1.4 -0.4 0.5 -1.8 3.7

Giving a value of EUR 61.4m (= 3.7(1.02)/(0.08144 - 0.02)) at a WACC of 8.144% and growth rate of 2% Alternative approach to calculating FCF: Free cash flow (FCF) is: Operating profit Deduct tax charge Deduct tax relief on finance charge (at 30% of 1.4) Add back depreciation Deduct funds reinvested FCF pre-financing cash flows

EUR million 6.7 -1.3 -0.4 0.5 -1.8 3.7

Additional value from synergistic benefits Annual benefit of EUR 0.7 million after tax That is, a total PV of EUR 8.6 million ( = EUR 0.7 million/0.08144 where 0.08144 is the value of WACC calculated earlier) taking future years into account.

The expected value of the synergistic benefits can then be added to each of the valuations already obtained above.

Summary of range of values of the assets employed in FR (that is, assuming that the assets employed in FR are sold without debt attached):

Net assets P/E ratio – M plc P/E ratio – PP DCF

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Pre-synergistic benefits EUR million

Post-synergistic benefits EUR million

58.0 69.6 77.0 61.4

66.6 78.2 85.6 70.0

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Examiner’s note: Note that it is the net assets employed by FR, without debt attached, that is being sold in this scenario. That is, the price paid must cover the value of both the equity AND the debt in this case.

Therefore: • Net assets have been calculated without deduction of debt.

• Debt has been added back to the standard P/E ratio valuation (which values the equity alone).

• No adjustment has been made to the DCF calculation since, in this example, this was based on the cash flows attributable to all providers of finance, both lenders and shareholders. The DCF calculation specified in the requirement was based on pre financing cash flows discounted at the (combined) weighted cost of capital.

(b) (ii) Net asset valuation The net asset valuation based on market values gives a value of EUR 58 million.

This is the minimum value that PP should consider paying but gives a useful indication of the assets employed in the business.

However, this valuation is not relevant when acquiring a company as a going concern, with the intention of retaining the assets and continuing to operate the business, as is the case here.

The value underestimates the value of the business as it does not take into account intangible assets such as the newspaper brand name that clearly have a value, despite the disappointing recent results.

Earnings valuations There are two main issues to consider when valuing FR based on earnings: • •

Choice of earnings figures.

Choice of P/E ratio.

We have used historic earnings from a single year in the valuation and do not have sufficient information with which to judge whether or not these are representative of sustainable future earnings.

We have been given two different P/E ratios in the question and have used each of these in the earnings valuation: • •

Using M plc’s P/E ratio, FR has a value of EUR 69.6 million.

Using PP’s P/E ratio gives a much higher value of EUR 77.0 million.

It is likely that PP’s P/E ratio is more appropriate than M plc’s P/E ratio in this scenario as we know that PP operates in the same market as FR whereas M plc operates in a number of different market sectors and geographical locations that are likely to have a different earnings and risk profile.

In applying PP’s P/E ratio, we are assuming that PP can produce the same rate of return from FR as from its current business activities. The validity of this valuation therefore largely depends on to what extent the relatively poor recent performance of FR is due to poor management by M plc rather than the popularity and future growth potential of the newspaper titles themselves. The indication is the former – that M plc acquired foreign titles that it was not able to develop to their full potential, possibly due to lack of local knowledge or sufficient management supervision. The valuation of FR using PP’s P/E ratio is based on the

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assumption that PP’s management can turn round FR’s performance and achieve the same returns as PP’s current business. It also assumes that PP and FR carry the same level of risk.

DCF valuations DCF valuations are generally considered to be the most appropriate method of valuation as they are based on the actual forecast free cash flows (before interest) of the business. These have been discounted at PP’s WACC adjusted for risk on the assumption that M plc has a similar gearing ratio to PP and give a valuation of EUR 61.4 million.

Note that the DCF approach gives a lower value than the P/E approach, raising further doubts over the validity of applying M or PP’s P/E ratio to FR. Note that using WACC and pre-financing cash flows is superior to using cost of equity and post-financing cash flows because FR’s gearing ratio is determined by M plc in line with the group’s requirements rather than being representative of how this type of business would be financed. In any case, without a quoted share price for FR it is not possible to determine FR’s WACC.

(b) (iii) In terms of negotiating a price, PP would be expected to offer a reasonable price at the bottom end of the valuation range in order to maximise profits and give room for manoeuvre.

This gives an indication of the likely minimum price that M plc is likely to achieve.

The price should not be lower than the net assets value (before synergies) of EUR 58 million.

The DCF valuation gives a slightly higher value of EUR 61.4 million. PP’s starting offer is likely to be somewhere between these two valuations.

The maximum price M plc could hope to achieve can be estimated based on the DCF valuation of EUR 61.4 million plus synergistic benefits estimated at EUR 8.6 million. This gives a top price of EUR 70.0 million.

Synergistic benefits are notoriously difficult to achieve in practice and so PP is unlikely to agree to a price as high as EUR 70.0 million even if it is extremely confident that the synergistic benefits can be achieved as PP would expect to take the benefit of the majority of those synergistic benefits.

The price of EUR 75 million that M plc hope to attain would, however, appear to be far too high and unlikely to be achieved. M plc will need to be prepared to accept a lower price.

(c) Competition authorities generally justify intervention in a proposed merger or takeover if they consider it to be against the public interest. For example, if the takeover would restrict competition in the market. As a rule of thumb, competition authorities may investigate an acquisition if it will result in the combined entity acquiring 25% or more of market share. It is highly likely that this will be true in this scenario, although we cannot be certain without additional information regarding PP and FR’s share of the French newspaper market.

Investigations can take several months to complete. The result of the investigation may be to allow the acquisition to proceed. However, there is a risk that the authorities could reach a less favourable verdict such as: • •

Allow the acquisition to proceed subject to certain conditions designed to help protect the consumer, or Block the acquisition altogether.

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Conditions imposed by the regulator in this scenario might include limiting the number of additional newspaper titles that PP is permitted to acquire or guaranteeing the continuation of the pan European English language paper.

There is also a risk that the prospect of a substantial delay while the investigation is conducted, together with the time required to cooperate with the investigation, may lead to PP abandoning the bid if the competition authorities decide to conduct an investigation into the bid. The level of interest that PP has in acquiring FR will affect to what extent PP is likely to pursue the bid even if there is an investigation.

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SECTION B

Answer to Question Two

(a)(i) FInancial objective 1: To increase dividends by 10% a year.

Before the acquisition, TTT’s earnings have grown by 8% per annum on average. The target growth in dividends of 10% is therefore is not sustainable over the long term without significant growth in earnings in the future.

Note that the variation in dividend pay-out between 30% and 50% of earnings may indicate an attempt to smooth dividend levels.

WWW’s long term earnings growth propects is lower than TTT’s at 6% per year and so the acquisition risks reducing long term earnings growth prospects. However, the combination of earnings from the two entities increases However, the target earnings growth of 10% can be expected to be achieved in the year of acquisition due to the addition of WWW’s earnings. Growth in earnings is expected to be boosted by 4.6% if funded by debt and by 10.85% if funded by equity (see workings).

Note that the impact on earnings per share varies considerably according to how the deal is financed. If financed by equity, earnings per share can be expected to fall as a result of the acquisition due to the greater number of shares in issue.

Workings: Earnings per share calculations

Pre acquisition

Earnings TTT: EUR 2,000m

Earnings per share for TTT Eps: 40 cents = 16 cents/40%

WWW: SKR 2,000m, or EUR 217m (where SKR 2,000 = 20,000m/10 based on a P/E = 10, and EUR 217m =SKR 2,000/9.2) Post acquisition, funded by debt (at 5% post tax interest) Post acquisition, funded by equity (assuming no change in share price)

EUR 2,092m, 4.6% increase (2,092 = 2,000 + 217 – (5% x 2,500))

Eps: 41.8 cents, 4.5% increase (0.418 = 2,092/5,000)

EUR 2,217m, 10.85% increase (2,217 = 2,000 + 217)

Eps: 37.8 cents, 5.25% decrease (0.378 = 2,217/(5,000 + (2,500/2.90))

FInancial objective 2: To keep gearing below 40% (where gearing is calculated as debt/(debt + equity)).

Based on market values the current gearing is 39.6%, which is only just under the target level of 40%. Gearing exceeds the limit if the acquisition is funded by debt (at 45.3%) but falls markedly to 35.8% if funded by equity. (See workings below.)

Using book values of equity, the gearing target is exceeded in all cases. Gearing improves if the acquisiton is funded by equity but remains well above the target level of 40%.

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Workings: Gearing calculations Gearing based on market values

Gearing based on book values

Post acquisition funded by debt (at a cost of EUR 2,500m that is SKR 23,000m/9.2)

39.6% = 9,500m/(9,500m+14,500m) 45.3% = (9,500m + 2,500m)/ (9,500m+2,500m+14,500m)

51.4% = 9,500m/ (9,500m +5,000m +4,000m) 57.1% = (9,500m + 2,500m)/ (9,500m +2,500m +9,000m)

Post acquisition funded by equity (assuming no change in share price)

35.8% = 9,500m/ (9,500m+2,500m+14,500m)

45.2% = 9,500m/ (9,500m +2,500m +9,000m)

Pre acquisition

FInancial objective 3: To expand by internal growth and/or by horizontal integration via acquisition of companies operating in the same industry sector.

The acquisition clearly helps towards the growth target. WWW represents horizontal integration in the same broad energy industry sector.

(a)(ii) The financial objectives are a rather strange combination. Dividend growth is a useful target but appears to be too high at 10% per annum and is not linked to company performance. It may be better replacing this objective with a lower minimum dividend growth figure coupled with a dividend payout target and an earnings or earnings per share growth target.

A dividend growth target without an earnings target could lead to payment of dividends in excess of what the company can afford – it is an easy target to meet if sufficient retained profits and cash are available or investments are cut but is not sustainable over the longer term if not underpinned by earnings growth.

The gearing target objective is reasonable, although it would be better if it defined whether gearing was based on book values or market values. Debt covenants may require this target to be met. Interest cover may also be important to lenders and may be stated in debt covenants. TTT should consider adding an interest cover target to its financial objectives.

The general growth target does not have any numbers attached. An earnings growth target or a growth in market capitalisation target could be added in order to enable this target to be quantified and success measured in financial terms.

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(b) Candidate answers should include a full description of any THREE of the following key roles of treasury during the evaluation and implementation of the acquisition: •

Advise on an appropriate discount rate for use in the evaluation of WWW with regard to: o Risk appetite of TTT and risk profile of WWW. o Currency profile of WWW’s cash flows. o Cost of capital of TTT.

•

Advise on appropriate funding of bid, including: o The choice of debt versus equity funding. o Choice of actual sources of finance.

•

Liaise with 3 parties: o Negotiate with lenders over interest rate, fees and covenants for bank debt. o Liaise with intermediaries regarding the issuance of bonds, including costing, publicity and other arrangements.. o Liaise with intermediaries regarding the costing and arrangements for a rights issue or placement of shares. o Controlled release of information to the market

•

Risk management aspects of the proposed acquistion, including: o Managing exchange rate risk (for example, through hedging or foreign currency borrowing) o Managing interest rate risk (for example, by choice of interest profile and/or interest rate swap) o Manage liquidity risk – forecast liquidity needs and ensure that sufficient liquidity is available at all times.

•

Assess reaction of the market in terms of: o Impact on credit rating and credit worthiness in general. o Impact on share price. o Impact on debt covenants.

•

Integration of WWW into central treasury systems. This might include: o Pooling of bank accounts o Standardising bank relationships o Regular cash forecasts o Reporting exchange rate risk o Controlling working capital

rd

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Answer to Question Three

(a) (i) Terms of the rights issue

25% discount

Suggested rights issue price $4.5

40% discount

$3.6

Terms of share issue required (see working)

Funds raised

2 for 5

$252m

196

1 for 2

$252m

210

Total shares

Workings: At 25% discount Number of shares to be issued is $250m/$4.5 = 55.6m rounded to 56m.

This gives terms of 56m/140m = 0.4 to 1 or 2 for 5 and funds raised of 56m x $4.5 = $252m At 40% discount Number of shares to be issued $250m/$3.6 = 69.4m round to 70m.

This gives terms of 0.5 to 1 or 1 for 2 and funds raised of 70m x $3.6 = $252m (ii) Yield adjusted TERP calculation Number of shares

At 25% discount

At 40% discount

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2 new shares at $4.50 x 20/15 5 old shares at $6.00 Total So yield adjusted TERP = $6.00

2 5 7

Total value of shares ($) 12.00 30.00 42.00

1 new share at $3.60 x 20/15 2 old shares at $6.00 Total So yield adjusted TERP = $5.60

1 2 3

4.80 12.00 16.80

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Value per share ($)

6.00

5.60

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(b) Assume a shareholder has 100 shares in DCD: $ Before rights issue Value of shareholding before rights issue (100 x $6.00): After rights issue at 25% discount Existing share value New shares Less capital to buy shares Value of shareholding after rights issue: After rights issue at 40% discount Existing share value New shares Less capital to buy shares Value of shareholding after rights issue:

100 x $6.00 40 x $6.00 40 x $4.50

100 x $5.60 50 x $5.60 50 x $3.60

600 $ 600 240 840 (180) 660 $ 560 280 840 (180) 660

(c) The concerns of Director A seem to be valid as the higher discount of 40% results in the yield adjusted TERP of $5.60 falling below the current market price of $6.00 whilst the current market price would be maintained using the lower discount of 25%. This is because at a 25% discount the impact of this discount on new shares would be exactly offset by the greater return projected from the new investment. However, as demonstrated in part (b) theoretically the level of discount makes no difference to shareholder value.

The point made by Director B has no validity in theory. A higher discount would require a larger number of rights to be issued. The total new investment required from each investor would be identical whichever discount rate is chosen and therefore have no impact on the extent of take up of the offer. However, in practice, a high discount rate can give the impression that the new shares are priced at a bargain level and take up can be higher. This also has implications for underwriting costs that can be lower if rights are issued at higher discount rates.

Director C is also correct in that the choice of discount will impact on the dividend payable per share because it will affect the number of shares in issue. However, the level of discount should have no impact on the total dividend paid to each shareholder (before considering issue costs – see below).

The cost of underwriting the rights issue may also be relevant to the choice of discount. On average this would be expected to be $5.04m (2% of $252m) but the agreed cost will depend on the terms of the issue and the level of discount. A higher discount may result in lower underwriting costs as the risk of the rights issue failing should be lower.

It is recommended that a discount of 25% is used since this avoids a fall in the share price assuming that project returns are achieved as forecast and may allow the company to continue with a more stable dividend policy.

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(d) The extent to which the share price is affected immediately before and in the 12 months following the announcement of the investment and the rights issue, will depend upon many factors including: • • •

The efficiency of the market.

To what extent the market agrees with the company evaluation of project benefits.

The degree to which the market supports the rights issue.

The efficient market hypothesis states that if a market is semi strong then it will react immediately to information as it is made public. A market in weak form means that the share price will react very slowly to new information and a market in strong form means that the share price will already reflect all information whether publicly or privately available. It is generally believed that markets are of a semi-strong form The share price has increased by 11% in the past three months which could be due to many factors including general market confidence, the release of good results or speculation that an investment needs to be made. Some information concerning the investment may have already leaked into the public domain and be reflected in the share price. The extent to which the share price moves after the announcement depends on the extent to which the impact of the investment has already been anticipated correctly. In the 12 months following the announcement further information about the project will be made publicly available and share prices should adjust to reflect this new information.

There may also be speculation about a potential rights issue and share prices may fall if there are any doubts about whether it will be fully subscribed.

Answer to Question Four

(a) (i) Calculation of NPV based on GBP discount rate Year ended 31 December Time Net operating cash flow (A$m) Investment – stores (A$m) Investment – refurb (A$m) Investment in working capital (A$m) A$ cash flows Exchange rate

Financial Strategy

2013 2 250.00

2014 3 350.00 450.00

(150.00) (735.00) 1.300

(15.00) 185.00 1.370

(16.50) 233.50 1.444

181.50 981.50 1.522

(565.38)

135.04 (14.00) 121.04 0.909 110.03

161.70 (14.00) 147.70 0.826 122.00

644.88 (14.00) 630.88 0.751 473.79

0 (415.00) (170.00)

GBP remitted cash flows Additional UK costs (GBP) Net GBP cash flows Discount factor at 10% Present value (GBP) NPV

2012 1 200.00

(565.38) 1.000 (565.38) GBP

140.4

13

million

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Exchange rates workings Date 01-Jan-12 31-Dec-12 31-Dec-13 31-Dec-14

Spot 1.300 1.370 1.444 1.522

Workings

Working capital workings Balance 01-Jan-12 150.0 31-Dec-12 165.0 31-Dec-13 181.5 31-Dec-14 -

=1.300 x 1.075/1.02) =1.370 x 1.075/1.02) =1.444 x 1.075/1.02)

Movement 150.0 15.0 16.5 (181.5)

(a) (ii) Calculation of NPV based on A$ discount rate Calculation of A$ discount rate (1 + A$ discount rate) (1 + GBP discount rate)

=

So, 1 + A$ discount rate

= = So use A$ discount rate of 16% Alternative approach: 1 + A$ discount rate

(1 + A$ interest rate) (1 + GBP interest rate) 1.10 x 1.075/1.02 1.1593

=

future spot rate current spot rate

=

1.300 x 1.075/1.02 1.300 1.1593

= So use A$ discount rate of 16%

x (1 + GBP discount rate)

x 1.10

Discounting A$ cash flows at A$ discount rate of 16% Year ended 31 December 2012 Time 0 1 A$m A$m A$ cash flows (735.00) 185.00 UK CF translated into A$ (19.18) Total A$ cash flows (735.00) 165.82

2013 2 A$m 233.50 (20.22) 213.28

2014 3 A$m 981.50 (21.30) 960.20

Discount factor at 16% Present value

0.743 158.47

0.641 615.49

NPV in A$ A$ Translate at spot of GBP/A$ 1.3000 giving a GBP value of: GBP

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1.000 (735.00)

0.862 142.93

181.89 million 139.93 million

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(b) The reason why the two calculations for NPV are almost the same (and indeed had a discount rate and discount factors been used to an accuracy of five decimal places been used, the answers would have been exactly the same) is because of the interest rate parity theory upon which the predictions of exchange rate are based.

Interest rate parity states that there is a relationship between foreign exchange rates and money markets. Other things being equal the currency with the higher interest rate will be at a discount in the forward market against the currency with the lower interest rate.

In terms of the approaches adopted in (a) both use interest rate parity, but in different ways.

The first approach uses it to adjust future exchange rates and the second uses it to adjust the discount rate. Because both are based on the same theory, ultimately they give the same answer.

(c) The additional risks involved in foreign investment include: • • •

Exchange rate sensitivities Less certainty over costs and revenues due to lack of familiarity with the market Uncertainty over management time and cost involved in overseeing the development and subsequent operations

These can be taken into account using: • • • •

Sensitivity analysis (of exchange rates and property values after 3 years and other individual costs and revenues) Certainty equivalents (applied to net operating cash flows to allow for lower returns) Using a risk-adjusted discount factor in the npv analysis, based on an assessment of additional risk and an analysis of the beta of businesses in the same sector Assessing alternative possible outcomes by applying probability of outcome to different scenarios

(d) Lessons learnt from previous UK projects could be useful to a certain extent. The basic implementation framework for UK projects can be applied to foreign projects but foreign investments have many additional complications which need careful monitoring and control.

Similar items include: • • •

Trial run Project team Budget control

However, the whole structure of the project team may need to be different. Decisions will need to be taken on, for example: • •

The location of the project team(s) Role of local management in the implementation

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New items that will need to be added to the project team’s agenda will include: • • •

Regulatory risk (working within a new regulatory regime eg different employment law and health and safety regulations) Human resource issues (employees in Asia may be used to different working arrangements) Control over foreign travel and accommodation costs

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