Question

Globex Corporation is a multinational construction company based in Istanbul, Turkey. The company operates primarily in Turkey, Eurasia, and the Middle East regions. The management team is considering two new mutually exclusive projects.

• The first project involves a giant construction project of a bridge that crosses the Bosphorus Strait in Istanbul. The firm would be a subcontractor and would build only part of the motorway that will connect the bridge to a main motorway system on the Asian side of Istanbul.
• The second investment option is a construction project of a sports center in Qatar that will be used for the FIFA World Cup. The project is a high-profile project and the firm can gain a significant reputation if the project is successful.

Each project requires an $80,000,000 initial investment for the investors of the firm and their IRR and payback figures are shown below.

	IRR	Payback
Bridge Project	18.2%	5 years
Sports Center Project	25.5%	3 years

Required:

1. Define working capital and discuss the effects of both projects on the firm’s working capital.
2. Define political risk and discuss the political risk for both projects and how a firm would mitigate this risk.
3. Define mutually exclusive projects. Identify and explain which project you would recommend based on the information presented, assuming both projects have the same level of political risk.
4. What other additional information would be helpful to evaluate these projects? Explain your answer.
5. Define hurdle rate and explain how a firm develops its hurdle rate.

The planned completion date for the bridge project is May, Year 1, and for the sports center, the completion date is December, Year 3. The sports center project also requires $1,000,000 of additional working capital in the short term. The hurdle rate for the company is 10%.

Answer 1

A. Define working capital and discuss the effects of both projects on the firm’s working capital.

Ans A : Working capital means the funds required for day to day operation. Business will require funds to invest in inventory, receivable, certain level of cash etc. On other hand they will get some funds in form of payable. So working capital means current assets - current liability.

The funds needs to be sourced for working capital and accordingly it will attract additional cost. Depending on level of working capital required it can change the IRR % of project since current IRR provided is only in relation to initial investment.

Higher the working capital requirement it will reduce the IRR of the project. The IRR of 25.5% with investment of $80M will have slight impact for working capital investment of $1M however it will not fall below 18.2%.

B. Define political risk and discuss the political risk for both projects and how a firm would mitigate this risk.

Ans B : The political risk is quite high in Bridge project since it is infrasturcture project which will be funded by government however their commitment may change considering priority they are having. Further under this project, the company is sub-contractor for specifc part & hence they would have limited visibility & infulence in relation to entire project

While on other hand Sports project, though this might also be government funded project but it is more certain in terms of commitment since FIFA is world famous event and hence brings higher commitment to project.

Further political risk is higher where project duration is longer hence Bridge project also subect to higher political risk

C. Define mutually exclusive projects. Identify and explain which project you would recommend based on the information presented, assuming both projects have the same level of political risk.

Ans C : Mutually exclusive project means the firm is in position to commit resources to complete only one project at a time while other project will be not be committed or considred.

In case of mututally exclusive project, the project with higher IRR is preferable subject to IRR is greater than cost of Capital. Since the sports complex project have IRR higher than bridge project hence sports complex project will be preferable

D. What other additional information would be helpful to evaluate these projects? Explain your answer.

Ans D : The project is accepted provided the IRR is greater than cost of capital. Hence the cost of capital will be required over here to make final decision

E.  Define hurdle rate and explain how a firm develops its hurdle rate.

Ans E : Hurdle rate is minimum acceptable reutrn over the porject. Usually it is cost of capital plus risk premum considering the risk involved in the project.