Questions and Solutions - Fuqua School of Business



Questions and Solutions

1. Most countries in sSub-Saharan Africa are fledgling democracies without long standing traditions of political stability and democratic processes. n countries have a very poor track record in relation to the respect of democracy and human rights. What ich considerations of a non-financial nature are relevant in evaluating investments in environments in “new-age nations”. about this point should a large international corporation make before investing in one of these countries?

Companies can have problems undertaking investments on these countries since these investments can significant unforeseen consequences that attract international attention (“the significance of negative skewness at the sovereign level”). have a bad repercussion worldwide. Investors should continue to abide by the same standards citizenship to which they are held accountable in domestic environments. On the other hand shunning these markets may have unintended consequences as a meaningful share of the world’s population is excluded from an increasing share of global economic activity. International investors are often very influential in the direction and growth of emerging economies and can adopt a strategy of constructive engagement to accelerate non-financial and monetary gains in the environments they place their financial and human capital. the boycott attitude as the one used by US government against CUBA is proved to be unproductive since it avoids the contact of country inhabitants with overseas’ ideas.

The best concept tends to be the constructive engagement in which the company undertakes the foreign investment without totally accepting the “status quo”. On this sense the company can bring modernization and new ideas for the country helping the transformation process.

2. What are the salient features of Zimbabwe’s sovereign risk and what characteristics of this deal help to mitigate these Zimbabwe risks at the Meikles Africa Limited level.

▪ Sovereign Risk.

▪ Political risks

▪ Unresolved property rights, especially with respect to the ownership of commercial agriculture land

▪ Financial risks

▪ Currency risks

▪ Inflation & money supply growth that erodes real earnings growth

▪ Rising interest rates

▪ Economic risks

▪ Rising budget deficits

▪ Presence of a local partner , with significant managerial expertise responsible for the responsible for daily operations of the business

▪ Meikles Africa Limited is a significant domestic business that enjoys significant market power with in its interactions with customers and suppliers.

▪ Relatively inflation and recession resistant businesses

▪ Minimal adverse exposure to currency risk. Aggressive business growth strategy that seeks development in new markets.

▪ Simultaneous listing on both the London exchange and the local exchange

▪ Cost structure of the company is not affected by exchange rates fluctuations

▪ Presence of a South African partner, with a lower perceived risk and a more advanced technology, show international confidence on the company

▪ Long business tradition of the acquired company and commitment of its own management with the ownership of the business

▪ As one of the first international exposures of the country any failure in relation to the International investor can represent a serious drawback

▪ Company had an outstanding loan with International Finance Corporation, backed by World Bank, of approximately 3.3 million dollars. This is an incentive to financial discipline since any problem financial difficulties with a multilateral agency can represent a serious set back for an emerging corporate and its economy.

3. Which discount rate would you use for this case?

For this company we believe the type nature of totally in-country house activities y developed makes the corporate level risk to be at least equal to that the country risk. In particular, we believe that the very nature of its retail trading operations and its large share of the domestic retail revenues, inextricable link the firm to the economic and financial factors in the economy of the country. There is no further reason to believe that the nature of these business activities is inherently riskier than that of the sovereign government. While foreign currency revenues from the hotel division may appear to mitigate some of the currency risk inherent at the sovereign level, we do not believe that the effects of these are significant for the following reasons;

• The requirements of the Reserve Bank in dealing with FCAs undermine any currency hedge in these revenues (which only exists on 60% of the collected revenues for 90 days)

• The relative minor contribution of hotel revenues to total revenues.

On this sense Wwe projected an initial required rate of 35 % (in United States dollars) for the equity part of the project that corresponds to the current cost of equity in Zimbabwe using the International Ccost of Capital calculator.

This discount rate is high. The concept of an emerging market, however takes in consideration that the country is in continuos development on this sense we lowered the cost of equity to 25 % after 5 years reflecting the expected progress on Zimbabwean economy.

Following the same logic we used a rate of 15 % for the perpetuity valuation since the risk factors of an emerging economy should disappear as this economy emerges. However, with respect to how quickly one gets to a low discount rate for the terminal value will depend in large measure on the investors time horizon and the rate at which the country will “emerge”.

Assuming that Zimbabwe GDP can grow at a rate of 7 % in US$ in the next 10 years? Do you think that this company will have a faster or slower growth rate? Why?

Internal characteristics of this company as the presence in attractive markets , the know how transfer from Pick ‘N’and Pay , the discipline imposed by the foreign partners and the huge investment in productivity will certainly mtake this company grow faster than the rest of the economy.

The spread is however hard to predict being advisable to work with a confidence range. Conservatively we used 3% on the attached spreadsheet.

4. Using your answer to 3 and 4 and the following assumptions value the company shares in october,1 1996

Assumption 1: Company tax rate equals 15 % for 97-2001 and 35 % after that. Do not forget that the company can count on carry forward of tax looses in the amount of Z$ 138,348,000

Assumption 2: In relation to inflation and exchange rates assume the follow

| |Zimbabwe Inflation |American inflation |

|1999-2001 |15% |5% |

|2001-2006 |10% |5% |

|After 2,006 |5% |5% |

Assume that the exchange rate on Zimbabwe will always devaluate according to the difference between the two-country inflation.

Assumption 3 : Assume an exchange rate of Z$10.00 to US$1.00 in March 1996 , also assume that the time of by the moment of the deal the company has already earned 50% of its their total profits and Cash Flow earnings for the fiscal year of 199796.

State clearly all the other assumption you are considering

Please see attached spreadsheet for answer.

5. What should Raymond ob advice on his presentation?

Raymondob should recommend advice the acquisition of shares since there is a comfortable margin between the share price and the company valuation, however he needs to make articulate clear to the board the high level of perceived risk involved, his expectations of future events in the country and within the firm. He needs to communicate how these risks and expectations are priced into the discount rates used in his valuation model. Lastly, Raymond should calculate a modified payback period and reconcile ex-ante and ex-post returns on a regular basis throughout the investment horizon. and the uncertainties in relation to future cash flows in US dollars.

Patterson . please add something about the completion of the deal and how the company performed thereafter to make the case complete. TKS.

Subsequent Events:

Meikles Africa Limited was successful in raising US$ 72 million from its private placement. The shares began trading on the Zimbabwe Stock Exchange on November 30, 1996 at a price of Z$ 23.00 a share. They traded up to Z$ 30.00 a share on November 6, 1996 before settling at Z$ 25.00 a share by year-end. During this time, the Z$ remained relatively stable, which allowed the international private investors to earn returns in excess of 70% in US$ terms. In the three years following the transaction, the company has achieved most of the goals it set forth to investors. Meikles Africa Limited has achieved real earnings growth by from geographic expansion in TM Supermarkets, store expansion in Clicks & Diskom franchise brands and recently acquired 50% shares in two leading international hotels, the Victoria Falls Hotel in Zimbabwe and the Cape Grace Hotel in Cape Town, South Africa. All of these developments were made possible by the significant financial capability that the company acquired from the private placement which has allowed it to consolidate its position in a market of financially constrained competitors. However, during the same period, the Zimbabwe economy experienced significant internal shocks that resulted in a 50% devaluation of the local currency against the US unit on November 14, 1997. Meikles Africa Limited margins and market share in its Zimbabwe business has remained largely unaffected by these developments.

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