632598256894

Source: CIA, World Factbook, available at https://www.cia.gov/library/publications/the-worldfactbook/geos/co.html#Issues
Robinson has a policy to focus on only the first five years of a venture for analysis purposes. Profits
after the five-year period will be important, but the government guarantee will have expired.
The expected total profits resulting from the joint venture per year are as shown in Exhibit 7.15.
Robinson has an average cost of new medium-term debt of 6% and estimates its cost of equity at
10%. Its capital structure is 20% debt and 80% equity. It adds between two and five percentage points
to its weighted average cost of capital (WACC) when deriving its required rate of return on
international joint ventures. Robinson plans to account for country and other risks within its cash flow
estimates.
Exhibit 7.15 Profits to joint venture of Robinson and CCB.
Robinson is mildly concerned about country risk because of the internal fighting in Colombia. Will
the rebels overthrow the Colombian government? Robinson estimates that there is a 5% probability of
this happening. If it does happen, Robinson expects to lose all profits from the joint venture beginning
in year 3.
Let‟s do the analysis to see if this venture is worthwhile.
Step 1
Determine Robinson‟s cost of capital and required rate of return for the joint venture in Colombia.
We start with the cost of capital. Remember that the weighted average cost of capital is equal to the
after-tax cost of debt multiplied by the weight of the debt in the capital structure plus the required
return on equity multiplied by the weight of the equity in the capital structure. Exhibit 7.16 shows our
numbers.
Now let‟s look at the required rate of return on the investment in Colombia. Since Robinson
estimates the risk to be toward the high end of its range, it adds 4% to the WACC to get the required
return: 8.78% plus 4% = 12.78%. The risk manager rounds this up to 13%.