Wilson Co Finance Assingment Help With Solution

Posted on March 20, 2017

Wilson Co Finance Assingment Help With Solution

 
The Wilson Company is a U.S. firm that is considering a joint venture with a Chinese firm to produce and sell videocassettes. Wilson will invest $12 million in this project, which will help to finance the Chinese firm’s production. For each of the first three years, 50 percent of the total profits will be distributed to the Chinese firm, while the remaining 50 percent will be converted to dollars to be sent to the U.S. The Chinese government intends to impose a 20 percent income tax on the profits distributed to Wilson. The Chinese government has guaranteed that the after-tax profits (denominated in renminbi, the Chinese currency) can be converted to U.S. dollars at an exchange rate of RM 1 = $.20 per unit and sent to Wilson Company each year. At the present time, there is no withholding tax imposed on profits to be sent to the U.S. as a result of joint ventures in China. Assume that even after considering the taxes paid in China, there is an additional 10 percent tax imposed by the U.S. government on profits received by Wilson Company. After the first three years, all profits earned are allocated to the Chinese firm.
 
The expected total profits resulting from the joint venture per year are as follows:
 
Year Total Profits from Joint Venture (in renminbi, RM)
1 RM 60 million
2 RM 80 million
3 RM 100 million
 
Wilson’s average cost of debt is 13.8 percent before taxes. Its average cost of equity is 18 percent. Assume that the corporate income tax rate imposed on Wilson is normally 30 percent. Wilson uses a capital structure composed of 60 percent debt and 40 percent equity. Wilson typically adds between 2 and 6 percentage points to its cost of capital when deriving its required rate of return on international joint ventures. While this project has particular forms of country risk that are unique, Wilson plans to account for these forms of risk within its estimation of cash flows.
 
There are two forms of country risk that Wilson is concerned about. First, there is the risk that the Chinese government will increase the corporate income tax rate from 20 percent to 40 percent (20 percent probability). If this occurs, additional tax credits will be allowed, resulting in no U.S. taxes on the profits from this joint venture. Second, there is the risk that the Chinese government will impose a withholding tax of 10 percent on the profits that are sent to the U.S. (20 percent probability). In this case, additional tax credits will not be allowed, and Wilson will still be subject to a 10 percent U.S. tax on profits received from China. Assume that the two types of country risk are mutually exclusive. This is, the Chinese government will only adjust one of its tax guidelines (the income tax or the withholding tax), if any.
 

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  1. Determine Wilson’s cost of capital and its required rate of return for the joint venture in China.

To find the weighted average cost of capital, you multiply the cost of each source of capital by its weight in the total capital.  It tells you in the problem that “Wilson’s average cost of debt is 13.8 percent before taxes. Its average cost of equity is 18 percent.” Debt is 60% of the total capital and equity is 40%.

The 13.8% for debt is the before tax cost.  To get the after tax cost, you need ot multiply by (1-tax rate), so we get:

13.8%  X  .7   =   9.66% for the after tax cost of debt.

The weighted average is 13% [ (.0966  x  .6) + (.18 x .4)  =  .1299 = .13]

Here’s another way to determine the cost of capital.

Wilson’s weighted average cost of capital is:
 
Kc = D/(D+E)x Kd (1-T) + E/(D +E)Ke
Kc  = (60%) (13.8%) (70%) + (40%) (18%) = 5.8% + 7.2%  = 13%
 
Assume Wilson applies a premium of 4 percentage points to its cost of capital for this joint venture, its required rate of return on this joint venture would be 17 percent. Wilson also attempts to explicitly capture some types of country risk in the estimated cash flows, as explained shortly.

  1. Determine the probability distribution of Wilson’s net present values for the joint venture.

Scenario 1:  Based on original assumptions
Scenario 2:  Based on an increase in the corporate income tax by the Chinese government.
Scenario 3:  Based on the imposition of a withholding tax by the Chinese government.
 
Scenario 1: Original Assumptions

 Year 0Year 1Year 2Year 3
Total profits in CHY060,000,00080,000,000100,000,000
Profits Allocated to Wilson Co.(50% of Total)030,000,00040,000,00050,000,000
Corporate income taxes imposed by Chinese government (20%)06,000,0008,000,00010,000,000
Profits to Wilson after paying corporate income taxes in China024,000,00032,000,00040,000,000
Wilson’s dollar profits received from China (based on exchange rate of CHY 1 =$.20)04,800,0006,400,0008,000,000
U.S. taxes paid (10%)0480,000640,000800,000
Cash flows from joint venture04,320,0005,760,0007,200,000

 
The present value interest factor equals one divided by (1 + interest rate)number of years
 
Using a required rate of return of 17% for year one it is 0.85470, for year two it is 0.73051 and for year three 0.62437.
 

YearCash FlowsPV of Cash Flows
Year 000
Year 14,320,0003,692,304
Year 25,760,0004,207,738
Year 37,200,0004,495,464
Total PV of Cash Flows 12,395,506

PV of Cash Flows: $12,395,506

Initial Investment: $12,000,000
 
Net Present Value = $12,395,506 – $12,000,000 = $395,000

Scenario 2: Increase in Income Tax

 Year 0Year 1Year 2Year 3
Total profits in CHY060,000,00080,000,000100,000,000
Profits Allocated to Wilson Co.(50% of Total)030,000,00040,000,00050,000,000
Corporate income taxes imposed by Chinese government (40%)012,000,00016,000,00020,000,000
Profits to Wilson after paying corporate income taxes in China018,000,00024,000,00030,000,000
Wilson’s dollar profits received from China (based on exchange rate of CHY 1 =$.20)03,600,0004,800,0006,000,000
U.S. taxes paid (0%)0000
Cash flows from joint venture03,600,0004,800,0006,000,000

The present value interest factor equals one divided by (1 + interest rate)number of years

Using a required rate of return of 17% for year one it is 0.85470, for year two it is 0.73051 and for year three 0.62437.

YearCash FlowsPV of Cash Flows
Year 000
Year 13,600,0003,076,920
Year 24,800,0003,506,448
Year 36,000,0003,746,220
Total PV of Cash Flows 10,329,588

PV of Cash Flows: $10,329,588

Initial Investment: $12,000,000

Net Present Value = $10,329,588 – $12,000,000 = -$1,670,412
 
Scenario 3: Additional Withholding Tax

 Year 0Year 1Year 2Year 3
Total profits in CHY060,000,00080,000,000100,000,000
Profits Allocated to Wilson Co.(50% of Total)030,000,00040,000,00050,000,000
Corporate income taxes imposed by Chinese government (20%)06,000,0008,000,00010,000,000
Profits to Wilson after paying corporate income taxes in China024,000,00032,000,00040,000,000
Withholding Tax at 10% 2,400,0003,200,0004,000,000
Profits to Wilson after Withholding Tax 21,600,00028,800,00036,000,000
Wilson’s dollar profits received from China (based on exchange rate of CHY 1 =$.20)04,320,0005,760,0007,200,000
U.S. taxes paid (10%)0432,000576,000720,000
Cash flows from joint venture03,888,0005,184,0006,480,000

 
The present value interest factor equals one divided by (1 + interest rate)number of years
 
Using a required rate of return of 17% for year one it is 0.85470, for year two it is 0.73051 and for year three 0.62437.

YearCash FlowsPV of Cash Flows
Year 000
Year 13,888,0003,323,073
Year 25,184,0003,786,964
Year 36,480,0004,045,918
Total PV of Cash Flows 11,155,955

PV of Cash Flows: $11,155,955

Initial Investment: $12,000,000
 
Net Present Value =  $11,155,955 – $12,000,000 = -$844,045
 

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