Your team was hired by an investment fund, Future Star Investment (FSI) to advise its Board of Directors on two investment alternatives which they are considering. FSI is a diversified fund. It invests in various sectors with holdings in both listed and unlisted companies e.g. manufacturing, energy, construction, retail, food, tourism. This year, FSI is considering investing AED 500m of its funds and has identified two businesses in two different sectors where the fund would like to acquire holdings. FSI is looking to invest in opportunities that would maximize the value of its shareholders.

These are:

Investment alternative 1: FSI is interested in the telecoms sector and has identified Emirates Integrated Telecommunications Company (Du) as a potential investment.

Investment alternative 2: FSI is also interested in the transport sector and has identified Emirates Transport Operator (ETO) which is a UAE-based publicly-traded company that operates a range of urban transport services (bus, tram, train) across the GCC region.

Your team's mission is to prepare a report, and a presentation to the Board, in which you present your evaluation of both investment alternatives. FSI have prepared a brief for each alternative (see Appendix) with a set of questions they would like you to answer. These are outlines below. Required:

Question 1: Your group is required to:

(a) Calculate the NPV of the project based on the Government's estimate of the franchise cost. Show NPV including and excluding the terminal value.

(b) Calculate the IRR of the project. Show NPV including and excluding the terminal value. (5 marks)

(c) Indicate ETO should invest in the project if it paid Government's expected franchise cost. Consider the impact of the terminal value in your evaluation.

(d) Calculate the payback period of the project by excluding the terminal value.

(e) Based on the payback period calculated in (d), should ETO bid for the project on the basis of the Government's estimate of the franchise cost?

(f) Estimate the maximum price which ETO could bid for this new franchise given that competition is expected to be strong for this project. Include terminal value in your estimate.

(g) Estimate what would be the maximum price ETO could bid and still achieve a three years payback on this new franchise?

Question 2: Your group is required to:

(a) Explain whether it is better for ETO to base its bid price on the NPV method or Payback method - you need to explain the advantages and disadvantages of the two methods, which one would you recommend and why?

(b) If ETO proposed to pay AED 500m for the franchise, which investment alternative would you recommend to FSI (i.e. alternative 1 or 2)? You may recalculate NPV and IRR for the franchise. Justify your answer by taking into consideration the most important risk factors faced by each investment proposition which are likely to affect the value of each business.

Investment  propositions brief Investment(here is the appendix )

Proposition 1 FSI is considering to invest in the telecoms sector of the UAE. It has identified Emirates Integrated Telecommunications Company (Du). Du is a popular network which is based in Dubai. The company has recently published its 2020 annual report and financial statements. This can be found from the Dubai Financial Market (DFM) website.

Investment Proposition 2 FSI is considering to invest in the transport sector of the UAE. It has identified Emirates Transport Operator (ETO). ETO is a UAE based publicly traded company that operates a range of urban transport services (bus, tram, train). [Note: ETO is a hypothetical case]. ETO has published its 2021 - 2026 strategy and it intends to become a major player in transport within the Middle East region. During the due diligence process, FSI has learned that ETO is interested in expanding its operations in the UAE. Indeed, the UAE Government would like to extend the train network throughout the country and has invited ETO to bid for the new project. The Government is considering to run the new network by offering a franchise to the successful operator. The rail infrastructure in the UAE is owned by the Government. The franchisee will need to own and operate all trains on the new network. The cost of the franchise will be paid to the Government in two instalments. 80% of the total amount bid is due at the start of the contract. The balance of 20% is due to be paid at the end of the second year. For this new project, ETO will need to order AED 250m of new trains (rolling stock). It will also need to use AED 75m worth of older rolling stock that is currently sitting idle. The company's finance department has estimated that ETO would sell the old rolling stock for AED 75m if it is not used in the new project. The working capital of the business will increase by AED 25m at the start of the franchise. Based on expected passenger numbers, frequency of services, and fares over the franchise period, operating cash flows over the five year operating period are presented in Table 1 below.

Table 1: Projected operating cash flows

Year 1 2 3 4 5

Pre-tax net operating cash flows AEDm 160 180 200 240 280

Beyond Year 5, the company expects its pre-tax cash flows to grow at 3% per annum. The company is mainly equity financed (80% of its capital) and has a total asset base of AED 3.5bn. The company's current cost of capital is 6%. ETO expects a minimum of 6% return on all rail franchise bids. ETO's policy is to achieve a three year payback on rail franchise operations.The UAE Government has announced that ETO will be exempt from corporation tax throughout the franchise period. ETO has not revealed yet how much it intends to pay for the new franchise. However, a Government minister had said in a press conference that they hoped to raise AED 750m from the auction.

Answer rating: 100% (QA)

Report on Investment Alternatives Emirates Integrated Telecommunications Company Du and Emirates Transport Operator ETO Introduction This report evaluates two investment alternatives for Future Star I... View the full answer