You are the recently hired chief of investments (CIO) at Farallon Capital Managers and have decided to

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Question:

You are the recently hired chief of investments (CIO) at Farallon Capital Managers and have decided to make an investment in Angola. You intend to invest in a bauxite mine1 . The mine is expected to cost 52 million USD to construct. In the first year the mine is expected to produce 210,000 (ton) ore. Each year thereafter the mine rate will grow at approximately 3.7% for 5 years and after that the mine will have reached capacity (0% growth after 5 years). The going rate of ore is 125,365 AOA per ton. The mine will have operating costs of approximately 80% of revenues and is expected to last 10 years with zero salvage value after the mine is depleted (you may assume straight-line depreciation and ignore depletion). You expect to take a joint- venture investment in Angola with a firm that will invest 20% of the up-front costs and Farallon will take the remaining 80%. Farallon has an equity beta of 1.2 and the expected U.S. market premium this year is 7.68%. Farallon has a current weighting of their capital of 80% equity and 20% debt, but they have a target rate of new investment capital allocations of 65% debt and 35% equity in order to increase their debt burden over time and enjoy higher ROI on newly formed investments. Farallon has historical debt costs of 5.6%, but it plans to issue debt to fund this investment which has a cost of 5.86% or alternatively they can take a floating-rate note which has a rate of LIBOR+0.35%; the current LIBOR rate is 5.50%. The Angolian firm intends to fund its 20% tranche of the project entirely with a floating-rate bond that will take an interest rate of LIBOR+1.25%. Assume in either case that the bonds are issued at PAR value and that there are no convertible options or warrants. You have analyzed the foreign financial markets and have come up with the following details. You expect the Angola Kwanza to USD rate to remain relatively stable over the next decade. However, you believe that the level of interest rates provided on euro-currency accounts held in London will continue to rise by as much as 0.10% per year. Additionally, you believe the price of Aluminium will rise at a rate of 3.5% p.a. and that this translates into a 1.5% increase in the price of bauxite ore (p.a.).

1) Assuming the US risk-free rate of interest is 0.25% p.a., and that the current exchange rate of Angola Kwanza to USD is 557.18 AOA to 1 USD, and that the U.S. tax rate is 35% but the Angolian tax rate is 0% what is the net present value (NPV) and internal rate of return (IRR) of this joint-venture and should Farallon agree to the prospective deal? (It is necessary for you to compute the JV’s WACC for this analysis.)

2) Should Farallon choose to invest using the floating-rate note or use the fixed-rate? Provide a sound rational for your decision.

3) Discuss the risks Farallon is facing in pursuing this foreign direct investment (FDI). How might you hedge that risk? Be sure to provide an analysis of both risks in cross-boarder acquisition/FDI as well as financial hedging you might perform.

4) Assuming that the investment will make up 5% of Farallon’s annual cashflows. Discuss whether or not you believe making the investment would open up Farallon to economic exposure in the Angolian Kwanza. Additionally, discuss how it might operationally hedge that exposure.