Introduction The project proposal Mr.

Zaven Demarchek, president of Port Arthur Timber Company (Canada) was approached and proposed by Cascamon Industrial S.A, a Brazilian Company for a joint venture. The proposal stated that PATCO should provide Cascamon with milling equipments costing around 13,393,596 Real which is approximately around 7,250,756 Canadian dollars (Exchange rate = 1.8427) and expert operating staff for the mill. In return to this PATCO will be allowed to cut 150,000 cu. metres equivalent to 63,610,000 board feet of lumber every year for next five years. Any other profit other than this would belong to Cascamon. The proposal also stated that all needed working capital will be provided by Cascamon but operating cost including the salary of operating manager would be divided in the proportion to the amount of lumber cut. In terms of depreciation PATCO will be allowed to depreciate its investment fully for tax purposes. Evaluation of the project The policy of PATCO is that they do not accept proposal which gives a return less than 15 percent, but according to Mr. Zaven and companys finance director Mr. Zablocki this project has additional risk involved such as foreign risk they tend to look for a return which is near to 20 percent in Canadian dollars and that too after the payment of foreign taxes. Hence, projected income statement was prepared at the end of December 2007 taking into consideration the current price of lumber which is 155.14 Real the agreed 150,000M 3 /year lumber cut. This gave a cash flow of 4,232,016 Real which is approximately 2287947 Canadian dollars. After this projection they found that though the project was not giving the required return of 20 percent but in this highly volatile market the project was very attractive to the company as it gave an internal rate of return of 17.5%. Scenario suggested by PATCO Future is something which no one can predict but their can a number of ways through which approximation about the future can be achieved. Zablocki and Demarchek suggest one of the way through which future inflation affecting lumber price index, general price index and labour wage index can be predicted. He suggested that the future index prices of these indexes for the next five years will be the same as that of the previous five years (for eg. the rise in inflation from 2002 to 2003 will be same as rise from 2007 to 2008 which is 11.8). (Trend shown in appendix 8) Criticism Since the inflation in 2007 was approximately 60 percent [(501.1-311.5)/311.5*100] of the general price index it is inappropriate to assume that in 2008 the inflation will be 14.9 as assumed by Zablocki and Demarchek. Thus, I would like to reject this inappropriate assumption and put forth my following assumptions and scenarios which I think would be more appropriate.

Common assumptions in all the scenarios: 1) The change in the general price index is due to inflation prevailing in the country. 2) Exchange rate inflation is calculated using purchasing power parity (unless mentioned) and the inflation rate of the foreign currency is assumed as the change in the GPI (General Price Index) 3) Canadian Inflation is assumed to be the same for all the scenarios which is take as 5%, 4%, 6%, 5%, 4% for 2008 to 2012 respectively. 4) Lumber price index, labour wage index, coeff. of depreciation and exchange rate index are all directly or some times inversely affected by general price index. Sometime there is no effect even if there in a change in the general price index due to some abnormal situations. 5) The tax rate will remain at 35 percent of profits before taxes. Taxes were payable shortly after the end of the operating year. 6) Discounting factors taken in all the scenario is the average inflation of GPI in the five years otherwise anyone would take a fixed interest term loan at a lower rate and enjoy the real inflation rate difference.

Scenario 1 (Decreasing trend) In this scenario, the most important assumption taken is that the inflation will decrease almost in the same relative way as it grew it the last five years. In the last five years the inflation of GPI has increased from 14.9% in 2003 to 61% in 2007. Thus in the same way this scenario shows that the GPI index has decreased from approximately 61% at the end of December 2007 to 53% in 2008 and back 15% at the end of fifth year 2012. Due to various government measures such as controlling the supply of money, interest rate factor etc has lead to decrease in inflation which will result in economic stability and more employment opportunities. The change in all the other indexes has also decreased due to decrease in inflation except for lumber price index which was inversely related to GPI in the year 2011 and 2012. This may be because of various non-financial factors such as change in government policies and the new government lead in restrictions in lumber cut or there might be environmental issues too which lead the lumber price index rise in those two years.
INDEX/YEARS LUMBER PRICE INDEX LABOUR WAGE RATE INDEX GENERAL PRICE INDEX COEFF. OF DEPRECIATION EXCHANGE RATE INDEX 2008 2009 2010 2011 2012

53 33 55 50 47.62

45 38 40 36 34.623

25 28 35 28 27.359

30 20 25 23 19.048

35 15 20 18 15.38

(% Change in Index) Conclusion Moderate level of inflation can increase investment in an economy which leads to faster growth. Thus, if the above scenario occurs in the economy in the next five years the investment would yield a negative return of C$648692 at a discount rate 35%. The internal rate of return of the project in this case is 27.5%. though company can go for the project as it yields more than the wanting return of 20% but they should take appropriate measures such as buy Canadian currency derivative products well in advance before accepting the proposal as the discount rate which is the average inflation rate of five years (assumption) is quite high.

Scenario 2 (Inflation remains flat) This scenario suggests that the inflation remains flat for the next five years. The percentage change in index or in other words inflation of GPI at the year end 2007 was nearly about 61% hence, flat change means the inflation for the next five years will remain nearly the same ( + 5%). This scenario may happen if measures taken by the government dont work out, or some work out or some may not. The wage rate index change is relatively low as compared to LPI and GPI this is because labour was easily available in Brazil (hypothetical). INDEX/YEARS LUMBER PRICE INDEX LABOUR WAGE RATE INDEX GENERAL PRICE INDEX COEFF. DEPRECIATION EXCHANGE INDEX Conclusion Thus, if the above change occurs in the economy in the next five years the investment would again yield a negative return of C$2587700 at a discount rate 58%. The internal rate of return of the project in this case is 33.4%. It would be very necessary for the company to think crucially if they want to go for this proposal as there is a large difference between the growth of money and the IRR. Hence, this assumption which is more likely to happen the company should again not go for the project as it is very risky. 2008 59.85 35.60 63 2009 56.85 33.81 59.85 53.87 53.66 2010 58.56 34.83 61.65 55.48 52.38 2011 55.63 33.08 58.56 52.71 51.04 2012 57.86 34.41 60.91 54.82 54.68

OF 56.7 RATE 55.98

(% Change in Index)

Scenario 3 (Averaging inflation) In this scenario the average increase in the last five years is taken into consideration for all the index. The trend of this scenario is created in such a way that it takes into account the lowest inflation in the last five years (i.e the change) and the highest inflation and thus might fluctuates in that range in the next five years. For eg: For GPI the average come upto 38.9% and the total will be appox 190% in the next five years hence the inflation in the next five years will fluctuate near the average. This scenario implies that government is striving hard to improve the economic situation and has achieved a bit of success. INDEX/YEARS LUMBER PRICE INDEX LABOUR WAGE RATE INDEX GENERAL PRICE INDEX COEFF. DEPRECIATION EXCHANGE INDEX Conclusion If the above scenario or if the above change occurs in the economy in the next five years the investment would yield a return of C$41436.79 and 30.25% IRR at a discount rate 30%. Thus according to the companies policy of wanting a return of 20% and if they think this might be the state of the economy in future they should accept and go ahead with the project proposal. 2008 40 33 40 2009 36 22 37 34 31.58 2010 39 24 38 35 30.15 2011 38 26 39 35 32.39 2012 37 28 36 33 39.82

OF 38 RATE 34.24

(% Change in Index)

Scenario 4 (Hyper inflation) This is a situation where the economy goes out of control. In this situation there is a large amount of money supply into the economy which is then not supported by the growth in the output of goods and services which results into an imbalance in the supply and demand for money including currency. Zimbabwe can be the best example to describe hyper inflation. The following below table is created by taking the average of the change in inflation of the last five years after taken into consideration change in the index. (i.e the change of the change) for eg: the change in the GPI from 2003 to 2004 is 42% from 11.8% so the change in inflation is 257% similarly the change of change is taken into consideration and average is taken out and then adjusted back for the next following years. (Table shown in Appendix 7) INDEX/YEARS LUMBER PRICE INDEX LABOUR WAGE RATE INDEX GENERAL PRICE INDEX COEFF. DEPRECIATION EXCHANGE INDEX Conclusion Thus, if the above disaster happens in the economy in the next five years the investment would yield a negative return of C$6670866 and 73.5% IRR at a discount rate 465%. There will be no question of investing if the company thinks that this can happen in the economy in future. 2008 104.31 52 108.08 2009 190.88 79.77 191.96 151.62 179.78 2010 349.32 122.37 341.31 252.30 316.01 2011 639.26 187.77 606.16 419.83 571.36 2012 1169.85 287.95 1076.55 698.6 1030.76

OF 91.12 RATE 98.91

(% Change in Index)

Scenario 5 (Inflation moving towards Deflation) There might be a situation wherein the current inflation may move toward deflation. That is the GPI moves from 140 in 2008 to 179.76 in 2010 and then comes down to 162.16 at the end of fifth year. This means that along with appropriate government measures there were global crises and recession in the world including Brazil wherein people were hit by huge financial losses in financial markets and real estates and hence dint have money to the spend. On the contrary the prices of lumber and the wage rate stopped increasing as compared to the general price index because its demand remained inelastic. This means whatever may be the scenario in the world timber consumption at this price will remain constant along with the wage rate. To improve this government can take some measure such as injection of electronic money like the UK government is currently doing to stop inflation to go into deflation. INDEX/YEARS LUMBER PRICE INDEX LABOUR WAGE RATE INDEX GENERAL PRICE INDEX COEFF. DEPRECIATION EXCHANGE INDEX 2008 40 26 40 2009 20 15 20 20 15.38 2010 15 4 7 10 1.05 2011 15 3 -3 5 -7.64 2012 15 2.5 -7 1 -10.90

OF 45 RATE 34.24

(% Change in Index) Conclusion Short term and medium term inflation by supply and demand pressure in the economy and is influenced by the relative elasticity of wages, prices and interest rates. Thus, if the company predicts the above scenario for the next five years the investment would yield a return of C$7856564 giving an IRR of 41.3% at 12% discount rate. Thus the company should go for the project if they think this is the future economic scenario. But again the project is seen to be very risk due to a large difference in the discount rate and the internal rate of return.

Scenario 6 (V scenario) (PPP not used to calculate exchange rate). In this scenario the inflation is bought to its normal place in the initial three years but since the inflation do not go into deflation because the pace in which it decreased in the initial three years was unbelievable so government started injecting billions of electronic money which actually did not exits. Thus, instead of decreased inflation getting controlled the whole economy reversed and there existed artificial hype of money supply which intern resulted into more inflation as there exist an imbalance of demand and supply of money in the economy. There can be various hypothetical situations in the country and one of them is given as that the country Brazil country was naturally gifted with more gold mines in some of its parts which helped them to increase their gold reserves and thus helped them maintaining their value of currency. There can non financial factors that can also occur and affect the labour wage rate index (2010, 2011) such as natural calamities, terrorist attacks or the country itself might have very less human resource available. INDEX/YEARS LUMBER PRICE INDEX LABOUR WAGE RATE INDEX GENERAL PRICE INDEX COEFF. DEPRECIATION EXCHANGE INDEX Conclusion Thus, if the above change occurs in the economy in the next five years the investment would yield a return of C$ 842883 and appox. 46.9% (IRR) at a discount rate 36%. Hence with this assumption which is more likely to happen the company should go for the project as it meets its need of achieving return of more than 20%. 2008 38 30 40 2009 24 20 25 20 5 2010 15 25 15 15 0 2011 38 45 40 38 5 2012 55 40 60 45 10

OF 40 RATE 10

(% Change in Index)

NON-FIANANCIAL FACTORS Although all risks are not financial, they do have an impact on the finance of a company. The various non financial factors that affect an economy which in turn might have an impact on PATCO are as follows: 1. POLITICAL RISK Before entering any country, a company needs to check the political stability of the host country. Similarly, PATCO needs to assess the political stability and also the attitude of Brazil towards foreign investors. Assessment of political risk can be done at two levels, namely, Micro-level and Macrolevel. Micro-level risk involves Firm-specific risk and Macro-level risk involves Country-specific risk and Global-specific Risk. These risks are explained in detail below. Firm-specific Risk: here in it is important to anticipate the effect of political changes on activities of a specific firm. It has been observed that, different foreign firms operating within the same country may have a very different degree of vulnerability to changes in the host country policy or regulations. Country-specific Risk: all firms, in the host-country, be it domestic or foreign are exposed to this risk. This risk is further divided into two: Transfer risk this can be defined as limitation on a companys ability to transfer funds in and out of the home country without restriction. When the government is running short of foreign exchange and cannot obtain additional funds by the means of borrowing or attracting new foreign investment, it limits the transfer of foreign exchange out of the country. This restriction is knows as blocked funds. Thus PATCO must understand the policies for repatriation. In case the government puts restrictions like this one, the PATCO will have problems transferring money to the parent company in Canada. Cultural and institutional risk Under this, many factors are covered like

o Human resource norms - Which would state that a certain proportion of employees should be employed who are a resident of the host country. In case this proportion is very high, it might be difficult for PATCO to fire the local Canadian employees to introduce employees in Brazil. o Corruption level in the country High corruption in the country means there are various problems prevailing in the country like bribery, extortion, cronyism, nepotism,

patronage, graft, and embezzlement. If the corruption is high in the host country, it is advisable for PATCO to not to enter such a country. o Religious heritage currently the environment is very hostile for foreign companies to enter into the country. The root cause of these conflicts is a mixture of religious fervour for some and for some politics. Thus the religious heritage of every country differs from the other and must be understood and then only decision must be made by PATCO to enter Brazil.

Global-specific risk: this type of risk has come to the forefront in the recent past. This covers various factors under it like o Terrorism and War: Terrorism is growing at a very fast pace. In the past we have experienced attacks by terrorist list the 9/11 and also suffered its aftermath. Foreign companies are exposed to this risk even more as compared to the local companies because they are considered as symbols of their respective parent countries. On considering this factor it is advisable for PATCO to be very cautious in selecting the country to enter. Environmental Concern: Foreign companies have been accused of exporting their environmental problems to other countries. Companies have also been accused for spreading global warming. Thus the government is getting stricter with their rules and regulations regarding environmental concern. Hence, PATCO must check that there are not many restrictions put by the government on the cutting down of timber.

2. ECOMONIC FACTORS These include economic policy, disseminated by government agencies and central banks, and economic conditions, generally revealed through economic reports. Economic policies include fiscal policy and monetary policy. Decisions made regarding spending practices and budget like taxation and government spending are stated herein. Monetary policies would give an in depth idea of the level of interest rate affecting supply and cost of money. Whereas economic conditions would throw light on inflation level and trends, along with economic growth and health. Thus, if Brazil has low tax rate, low inflation and a healthy economy then PATCO must enter into the JV. 3. INTERNATIONAL TAXATION Taxation plays a major role in the success of any organization. The tax policies and regulations must be understood before entering into any country. If the country favours a particular industry, many tax benefits and subsidiaries would be offered which would be very good for the company. This being the case, PATCO should enter Brazil; else if heavy tax is levied on them, PATCO shouldnt enter Brazil. Also it must understand the multinational taxation and constraints on profit repatriation. 4. INTERNATIONAL PORTFOLIO DIVERSIFICATION

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This non-financial factor can be better explained with an example. If you take an example of these two international companies Brazil and Canada, and both invests in one another country and Brazilian economy faces some uncertainties then at least Brazil can save its diversified part of the portfolio. 5. ADVANTAGES OF JOINT VENTURE A joint venture is a strategic alliance between two or more individuals or entities to engage in a specific project or undertaking. It can have various advantages like:
Provides companies with a prospect to gain new capacity and expertise. Thus PATCO can

expand by entering into the Joint Venture. Access to greater resources, like specialized technology and staff can be made available. Although staff has to be brought in by PATCO, it has access to technology used by Cascamon. Allow companies to explore new geographic markets and also gain more technological knowledge. Various Risks could be shared between the two companies. Joint ventures can be flexible in term of the life span. For example, it can have a limited life span and only cover part of what you do, thus limiting both your commitment and the business' exposure. In the era of divestiture and consolidation, JVs offer a creative way for companies to exit from non-core businesses. Companies can gradually separate a business from the rest of the organisation, and eventually, sell it to the other parent company. Roughly 80% of all joint ventures end in a sale by one partner to the other. Thus PATCO could buy Cascamon and enjoy a larger market share in the Brazilian market.

DISADVANTAGES OF JOINT VENTURE A Joint Venture is like an arrange marriage of two companies which could create major issues when the two companies start working together. It takes time and effort to build the right relationship and partnering with another business can be challenging. Problems are likely to arise if:
The objectives of the venture are not 100 per cent clear and communicated to everyone

involved.
There is an imbalance in levels of expertise, investment or assets brought into the venture by

the different partners.

Different cultures and management styles result in poor integration and co-operation. The partners don't provide enough leadership and support in the early stages. Success in a joint venture depends on thorough research and analysis of the objectives.

Conclusion PATCO has four available options to deal with the above mentioned factors of risk it can either it ca a) Avoid, b) Eliminate, c) Mitigate/Manage, d) Accept. Thus, taking into consideration all the above scenarios I would recommend PATCO to understand each factor well and accordingly make decisions.

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Words = 3018 (excluding tables and appendix)

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