Question

a) Scandina Corp., a Swedish furniture producer, plans to establish a subsidiary in Malaysia in order to penetrate the Asian market. The company’s managers believe that the value of Malaysian ringgit is relative weak now and will strengthen against the Swedish Krona over time. If their expectations about ringgit’s value are correct, how will this affect the costs and earnings of the project? Explain.   

b) Scandina Corp. is also considering a joint venture with a Malaysian company IDEAL AS for two years. Scandina will invest 20 million ringgits to help to finance IDEAL’s production. For each of the two years, 50% of the total profits will be distributed to the Malaysian company and the other 50% will be converted to krona to be sent to Sweden.

The estimated total profits resulting from the joint venture per year are as follows:
Total Profits (in ringgits) Performance Probability Year 1 Year 2 Strong 80% 30 million 50 million Poor 20% 10 million 20 million

Scandina is concerned about the country risk that the Malaysian government is likely to increase the corporate tax rate imposed on joint venture from 10% to 20% beginning from Year 1 and the possibility is 50%.

Scandina’s average cost of capital is 12 per cent and it automatically adds 3 percentage points to it cost of capital when deriving required rate of return on international joint venture projects. Though this project has particular form of country risk that is unique, Scandina plans to account for the form of risk within its estimation of cash flows.

Required: Determine the expected net present value of Scandina’s investment. Would you recommend Scandina to participate the Joint Venture? Explain.

c) Scandina finally decided to penetrate Malaysian market by purchasing an 80% stake in IDEAL AS, a Malaysian company that produces furniture. How can borrowing Malaysian ringgit locally from a Malaysian Bank reduce the exposure of Scandina to (i) exchange rate risk and (ii) political risk caused by government regulations?   

Answer 1