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Gandor Long-Term Assests and Liabilities Management

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ASSESSMENT 4

Long-Term Asset and Liability Management

Gandor Company is a U.S. firm that is considering a joint venture with a Chinese firm to produce and sell DVDs. Gandor will

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Solution Summary

This is a solution from assessment 4 detailing Gandor Company's long-term assets and liabilities management. Some of the questions include:

Determine Gandor's cost of capital. Also, determine Gandor's required rate of return for the joint venture in China.
In determining Gandor's weighted average cost of capital we use the following equation.

There are 5 questions in total.

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ASSESSMENT 4

Long-Term Asset and Liability Management

Gandor Company is a U.S. firm that is considering a joint venture with a Chinese firm to produce and sell DVDs. Gandor 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 Gandor. The Chinese government has guaranteed that the after-tax profits (denominated in yuan, the Chinese currency) can be converted to U.S. dollars at an exchange rate of CHY1 = $.20 per unit and sent to Gandor Company each year. At the present time, no withholding tax is imposed on profits sent to the U.S. as a result of joint ventures in China. Assume that even after considering the taxes paid in China, an additional 10 percent tax imposed by the U.S. government on profits received by Gandor 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 yuan, CHY)
1 CHY60 million
2 CHY80 million
3 CHY100 million

Gandor'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 Gandor is normally 30 percent. Gandor uses a capital structure composed of 60 percent debt and 40 percent equity. Gandor automatically adds 4 percentage points to its cost of capital when deriving its required rate of return on international joint ventures. Though this project has particular forms of country risk that are unique, Gandor plans to account for these forms of risk within its estimation of cash flows.

Gandor is concerned about two forms of country risk. 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, ...

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