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313LON International Investment Analysis Assignment
This 313LON international investment analysis assignment discusses about the international investment analysis related to investment to be made by an existing transnational corporation based at United Kingdom in the housing construction sector in Chile, South America. The details will be included regarding the opportunities and risks to be faced by the company while investing in international market and methods to minimize such risks. This report will also discuss the challenges of International financial management. The calculations of projections of cash flows related to the investment to be made in Chile and calculations of discounted cash flows have also been included in this report for proper analysis and understanding. The report is made in context of analysis of micro and macro environmental factors of Chile which may affect the investment in Housing construction sector of the country.
Analysis of macro environment of Chile
A company adopts the policy of investing in other countries through foreign direct investment route or any other method of entering into the foreign market in order to gain the advantages of the synergies which are achieved by collaborations or joint ventures with other countries. The selection of the country to invest and the sector in which the investment is to be made is a crucial decision for any company. The risks and opportunities in the housing construction sector are analysed below to make recommendation to the investors about potential for such investment.
Risks of investing in Chile
The economy of Chile has been the fastest growing economy of Latin America. It largely depends on the mineral sector which accounts for 40% of the exports. Due to this the copper prices have a huge impact on the country’s economy and currency rate, making the currency volatile in the foreign exchange market. The Chilean Peso (CLP) has been depreciating since May 2013 until 2016 the reasons being decline in copper prices which is the major export of Chile, appreciation of US Dollars and decrease in external demand. The appreciation seen recently is only because of the impact of Brexit and weak level of US dollars. This shows that there is a high risk of exchange rate volatility in Chile therefore investing in British Pounds by the UK Company may result in less returns then the amount invested.
Apart from this the taxation rates for corporate in Chile is continuously increasing which has reached to 24% in 2016 as compared to 21% in 2014. However there are non-discriminating taxes policies for foreign investors and tax exemptions and facilities are also provided but the repatriated capital is not taxed at the same level of invested funds. This is the risk factor for investors being excessive costs of tax in the country for corporate collaborating with foreign investors.
The major exports of Chile include copper contributing to 40% and other exports include food and machinery and the main imports include energy products and chemicals. The balance of trade in Chile is highly fluctuating since last few years and was negative in 2015. (OECD, 2012)
Tools to mitigate the risks while operating in international environment
- Hedging –This tool is used to protect the business against the risk of foreign exchange fluctuations and currency conversion. This method is used by the financial managers and investment analysts by entering into an opposite contract and agreement as against the existing contractual obligation of the business which has the exposure of risk of exchange rate fluctuation. For example if the business will receive $1,00,000 after 3 months then in order to hedge these receivables it shall enter into a three month forward contract for sale of $1,00,000 so as to protect itself from the changes in the exchange rate of dollars in terms of pounds.
- Insurance –This tool is used to transfer the risk to other party against the consideration paid to that party which is insurer. This is used to manage the risks arising out of breach of contract, loss due to theft, damage, regulatory changes, legal compliances, foreign exchange fluctuations and other related risks which can be transferred.
- Credit Rating –This technique involves using the services of crew=did rating agency to evaluate the feasibility of the business proposal and the potential and credit worthiness of the international business in which the funds are proposed to be invested buy the firm operating in international environment.
- Interest rate and currency swaps –These are the agreements entered into by the company to prevent itself from the risks related to the fluctuations in the interest e=rates and foreign exchange rates over the time among different countries. The agreement for exchange of fixed payment of periodic instalments is made between two parities operating in different environment or belonging to different countries so that the advantages of arbitrage opportunities can also be availed by them along with the minimisation of their credit and liquidity risks.
- Effective management –The commercial risk can be reduced by proper and efficient management of business by adopting best practices, procedures and methods. When effective decisions will be taken by the management in relation to operations of the business the reasons giving rise to the commercial risk for the company in international environment will not articulate. (Northcott, 2015)
Opportunities for investing in Chile
There is a wide range of opportunities for investment in Chile. It is ranked 17th in the world and second in South America for being attractive for FDI. The policies of country are favourable for foreign investors being transparent and non-discriminatory. There is no need of a local partner also for investing in the country. The rate of unemployment in Chile has stayed stable in 2016 being 6.3% as compared to 6.2% in 2015. Apart from this the employment rate is below the average rate of employment of OECD countries. This creates the opportunity of cheap labour force in the country. The GDP has grown by 2% in 2016 as compared to 1.5% in 2013. The GDP forecast is 3.02% for next year and 2.56% for 2020. The per capita income is growing fast and has doubled in recent years resulting in increase in the purchasing power of the people as a result of higher average income. The demand for products will also increase due to expanding middle and upper class.
The inflation in the country is temporarily high being 4% due to the depreciation of currency but it is predicted to decrease in the next years up to 3%. The interest rate which is raised by the Central Bank to 3.5% is due to increase in inflation and is expected to get low again. (Central Bank of Chile)
Opportunities within the housing construction sector in Chile for firms operating in international environment
The young and growing population in Chile consists of a large part of total population of the countrywhich creates market for the housing construction business being increasing demand of houses as a result of increase in such type of population. The increase in the middle class and disposable income of the citizens of the country being $18,900 per year in 2016 which is the result of increase in per capita income and purchasing power creates the opportunity for a huge rise in demand for residential houses at affordable prices in the country. Along with this the low and middle income housing is also increasing in the country creating a wide market for the housing construction business. The mortgage market has also increased from 11.1% in 2001 to 18% in 2012 which shows that the residents can afford housing loans as the availability of long-term mortgage is 5 to 30 years with 100% financing. The house prices in the country are also increasing since past few years and are predicted to stay stable. Thus the chances of huge revenues from sale of houses are visible.
Cash flow projection and discounted cash flow valuation
The UK based company is considering the entry into the housing construction sector of Chile by entering into joint venture with an existing Chilean construction company namely Salfacorp. Since the investment is to be made by the company in Chile the evaluation will be made in terms of Chilean Peso (CLP) being the currency of Chile.The cost of equity of the company is 17.16% and the cost of debt is 0.00% The Beta is 2.25 times and the beta adjusting factor is 0.45.The return on equity is 8.55%. The interest rate in Chile is 3.5% which shall be considered as risk free rate. The tax rate of the company is 24%. The cost of equity of the joint venture can be calculated using CAPM model as follows:
Cost of equity = Risk free rate + Beta X Market risk premium
= 3.5% + 2.25(8.55-3.5)
The joint venture will include capital investment initially 6,25,000 CLP out of which 1,25,000 CLP will be owner’s equity i.e., 20% of total investment and 5,00,000 CLP which is 80% of total investment will be financed from debt bearing an interest rate of 3.5% (assumed). The Weighted Average cost of capital can be calculated as follows:
Weighted average cost of capital will be 14.86%X 0.20 + 3.5 %(1-0.24)X 0.80 = 5.1%.
The beta of the company is more than 1 which means that the cost of capital calculated using CAPM is more volatile and risky. The weighted average cost of capital of the joint venture will be 5.1% if the debt is taken as 80% and equity is 20%. The cost of debt of the Chilean company is nil but the joint venture will require debt financed by loan bearing an interest rate of 3.5% The cost of debt is less in Chile which reduces the overall cost of capital of the investment since the cost of equity as calculated using CAPM model comes out to be 14.86% which is very high even than the return on equity of the Chilean company Salfacorp. Thus it can be observed that the project seems to be profitable. (BMI, 2015)
Cash Flow projection for three years
Number of Houses
Owner's Equity (20%)
Total Cash Received
Cost of Gds Sold/Inventory
Payroll Taxes & Benefits
Maintenance & Repair
Vehicles – Fuel
Total Cash Paid Out
Cash Payments to Loans
Net Cash Flow
Calculation of Discounted Cash Flow
Cash Flow after tax @24%
Discounting factor @ 2.66%
Discounted Cash flow
From the above mentioned analysis and detailed discussion in the report about the opportunities and risks for investment in the international market, challenges of financial management and the applicability of these factors in the context of proposal of investment by an existing UK based company in the housing construction sector of Chile and forecast of cash flows for the three years related to this project and calculation of discounted cash flow it can be calculated that the company can generate huge amount of cash flows through this investment proposal. The investment proposal in Chile has high potential to support the growth of the company. The rate of interest in Chile is quite low which is favourable condition for the company and apart from this there are many opportunities for the success of company in the international environmentof Chile. (Yong, 2014)
On the basis of evaluation and analysis of international investment, business proposal and the business environment of Chile and conclusions drawn there from it is recommended to the UK company to enter the Chilean market through a Chilean company to avoid the country risks and other risks by availing the advantage of division of losses and assets with the Chilean company. It is also recommended that the company establish its place in the market as limited liability Company to avail the benefits. The company is recommended to make arrangements for mitigating the risks while operating the business of housing construction in Chile by using the solutions suggested above. (Serpell, 2002)
BMI Research (2015) Industry Trend Analysis : public investment to boost infrastructure growth [online] Available from http://www.infrastructure-insight.com/industry-trend-analysis-public-investment-boost-infrastructure-growth-may-2015 [Accesssed 15th May 2016]
Central Bank of Chile, (2006) Statistical Synthesis of Chile Chile: Productora Gra?fica Andros Ltda
Krayenbuehl, T. (2001) Cross-border Exposures and Country Risk Assessment and Monitoring. Cambridge: Woodhead Publishing
Litterman, B. (2004) Modern Investment Management: An Equilibrium Approach. United States of America: John Wiley & Sons
Narisica, E. and Minsky, H. (2000) Finance, Investment, and Economic Fluctuations: An Analysis in the Tradition of Hyman P. Minsky Edward Elgar Publishing