Reference no: EM132508802

Point 1: Bavarian Motor Works (BMW) is a Germany registered plc that has a plant situated in Port Elizabeth, South Africa. The plant manufactures expensive, built to order, right hand drive (BMW) luxury cars for the African commonwealth market. The plant has been in operation for over 40 years. The company has seen an unprecedented year on year growth in revenues and profits over the past 25 years. This growth has been attributed largely to South African companies being exposed to international markets since the advent of democracy in 1994. The quality of South African products has taken international markets by storm. All the right hand drive BMW cars for the African commonwealth markets are manufactured by the plant in Port Elizabeth.

Point 2: The BMW plant in Port Elizabeth has been supplying all other commonwealth African Markets with expensive, built to order, right hand drive luxury BMW cars except for the Botswana market. Currently, the Batswana customers have been ordering directly from South Africa. The management of the South African division of BMW is considering extending the distribution network into Botswana.

The financial manager has carried out a detailed assessment of costs and revenues of opening a distribution network in Botswana. These are given below as follows:

Initial outlay needed: 9 million Botswana Pulas

The expected cash inflows in Botswana Pulas, net of tax are given below:

 Year                                        1            2       3               4

Cash Flow (millions of Pulas) 3.5        5.9     5.0          7.0

The following information has also been made available:

1. Expected inflation rate in Botswana 3% per year
2. Due to the fact that South Africa and Botswana are in the same customs union, the real interest rates are expected to be the same.
3. Assume the current spot rate is: Botswana Pula 1.3 per 1 ZAR
4. The treasury bonds in Botswana carry an interest rate of 4 percent per annum and in South Africa they carry 5 percent per annum.
5. The company's current WACC is 14 percent. This is used to evaluate all investment decisions.
6. The company's current capital structure is composed of R20 million in shareholder's funds and R4 million long term debt. The debt is redeemable in 2 years' time

• According to the presentation made by the financial manager to the board of directors part of the investment can be financed from the cash flow, but since it is also expanding operations in South Africa, the Chief Executive officer prefers external finance if it can be found on favourable terms. The financial manager has noted that the borrowing rates Euro-debt market is favourable. At 3% the rates are below those in both South Africa and Botswana.

Required:

Question a) Determine the Rand net present value of the project using the following methods:

I. By discounting annual cash flows in Rands

II. By discounting annual cash flows in Pulas

Question b) Discuss the following:

1. Discuss both in general terms and as it applies to [BMW] the use of WACC as a discount rate in international operations

2. The risks faced by BMW when it moves into an international market and how it might manage these risks

3. The methods of financing international operations and the factors that the company needs to consider before deciding to borrowing in Euro debt