Prepare answers to each of the questions and application problems indicated below. Your response should include a statement of the problem or question, along with your answer and narrative analysis as needed.In your International Financial Management textbook, complete the following:”Long-Term Asset and Liability Management,” Part 4: Integrative Problem, Questions 1–6, pages 569–570.In all cases where numeric solutions are expected, provide full documentation of the process used to reach the solution, using Excel to provide computational details.Where analysis is expected, use information from the textbook to inform your analysis—not replace it—incorporating creativity, critical thinking, and real-life perspectives. Cite all resource materials used in your response with APA (6th edition) style and format.A thorough, professional presentation of your analysis and results is an important consideration. Enhance your presentation skills by using applicable tools, such as tables, graphs, diagrams, and commentary as appropriate in all assignments in this course.PART
Long-Term Asset and
Gandor Co. is a U.S. firm that is considering a joint venture with a Chinese firm to pro-
duce and sell DVDs. Gandor will invest $12 million in this project
, which will help to
finance the Chinese firm’s production. For each of the first 3 years
, 50 percent of the
total profits will be distributed to the Chinese firm, while the remaining 50 percent will
be converted to dollars to be sent to the United States. The Chinese government intends
to impose a 20 percent income tax on the profits distributed to Gandor. The Chinese
government has guaranteed that the after-tax profits (denominated in yuan, the Chinese
currency) can be converted to U.S. dollars at an exchange rate of $.20 per yuan and sent
to Gandor Co. each year. At the current time, no withholding tax is imposed on profits
sent to the United States as a result of joint ventures in China. Assume that after consid-
ering the taxes paid in China, an additional 10 percent tax is imposed by the U.S. gov-
ernment on profits received by Gandor Co. After the first 3 years, all profits earned are
allocated to the Chinese firm.
The expected total profits resulting from the joint venture per year are as follows:
TOTAL PROFITS FROM JOINT VENTURE (yuan)
Gandor’s average cost of debt is 13.8 percent before taxes. Its average cost of equity is
18 percent. Assume that the corporate income tax rate imposed on Gandor is normally
30 percent. Gandor uses a capital structure composed of 60 percent debt and 40 percent
equity. Gandor automatically adds 4 percentage points to its cost of capital when deriv-
ing its required rate of return on international joint ventures. Though this project has
particular forms of country risk that are unique, Gandor plans to account for these
forms of risk within its estimation of cash flows.
Gandor is concerned about two forms of country risk. First, there is the risk that the
Chinese government will increase the corporate income tax rate from 20 to 40 percent
(20 percent probability). If this
, additional tax credits will be allowed, resulting
in no U.S. taxes on the profits from this joint venture. Second, there is the risk that the
Chinese government will impose a withholding tax of 10 percent on the profits that are
sent to the United States (20 percent probability). In this case, additional tax credits will
not be allowed, and Gandor will still be subject to a 10 percent U.S. tax on profits
Part 4 Integrative Problem: Long-Term Asset and Liability Management
Wiht on the Chinese government will adjust only one of its taxes (the income taxe
received from China. Assume that the two types of country risk are mutually exclusive.
1. Determine Gandor’s cost of capital. Also, determine Gandor’s required rate of return
for the joint venture in China.
venture. Capital budgeting analyses should be conducted for these three scenarios:
Scenario 1. Based on original assumptions
Scenario 2. Based on an increase in the corporate income tax by the Chinese
Scenario 3. Based on the imposition of a withholding tax by the Chinese
3. Would you recommend that Gandor participate in the joint venture? Explain.
4. What do you think would be the key underlying factor that would have the most
influence on the profits earned in China as a result of the joint venture?
5. Is there any reason for Gandor to revise the composition of its capital (debt and
equity) obtained from the United States when financing joint ventures like this?
6. When Gandor was assessing this proposed joint venture, some of its managers
recommended that Gandor borrow the Chinese currency rather than dollars to
obtain some of the necessary capital for its initial investment. They suggested that
such a strategy could reduce Gandor’s exchange rate risk. Do you agree? Explain.
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