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1.0 Introduction

Australia Japan Cable (AJC) is a submarine cable network that links the east coast of Australia with Japan

via Guam. AJC provides an optical fiber ring with an ultimate capacity of 3! " 3! Gbit#s. $t is a %&!

million submarine telecommunication cable system. 'here are two landing points in each of Australia

Guam and Japan and in each case cables from the landing points oin at a branching unit in deep water

offshore and proceed as a single sheath to the ne*t branching unit. $n the case of Australia the branching

cables oin some !! km offshore in water greater than +!!!m depth. 'he Australian landing points are

located at 'amarama and ,arrabeen both in -ydney. 'he cable stations associated with these landing

 points are at addington and /*ford 0alls respectively and the cable stations are linked to each other and to

the beach manholes via land cables. /riginal sponsor groups are 'elstra Japan 'elecom 'eleglobe and

 potential sponsor groups are A'1' ,'' and 2C$ orldCom. AJC commenced operational service in

4ecember !!5.

'he cable configuration comprises two physically separate cable stations connected by fiber in each of

Australia Guam and Japan enabling continuing access to each country should any repairs be re6uired to

one of the two landings to a country. 'o enable onward connectivity the AJC network provides access to

high capacity high volume low unit cost trans7acific and intra7Asia cables via Guam and Japan. AJC was

upgraded with +!G technology in mid !5 and with 5!!G technologies in late !53 and early !5+. $t is

currently e6uipped to about 5!!!Gbit#s Australia7Guam7Japan and has a potential capability to over&!!!Gbit#s enabling further upgrades as re6uired.

1.1 Objective of the Case

'he obective of the case is to evaluate this investment opportunity and report to management

with opinion about whether or not the company should go ahead with this proect.

$dentify the possibilities 1 problems of investment in Australia7 Japan through re6uired

factors like economic political financial condition.

4etermine 4iscount 8ate ,9 $88 2$88

4etermine economical environmental political risk and social situation

'o know how to take capital investment decisions

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2.0 Analysis of the Economy:

2.1 Economy analysis of Australia: 'he economy of Australia is one of the largest mi*ed market

economies in the world with a G4 of :-%5.&& trillion. Australia;s total wealth is <.+ trillion dollars. $twas the 5th largest national economy by nominal G4 and the 5=th7largest measured by 7

adusted G4 about 5.=> of the world economy. Australia is the 5?th7largest importer and 5?th7largest

e*porter. 'he 8eserve @ank of Australia publishes forecasts of the economy 6uarterly.

'he Australian economy is dominated by its service sector  comprising <> of G4. 'he mining sector

represents => of G4B including services to mining the total value of the 2ining $ndustry in !!?75! was

.+> of G4. conomic growth is largely dependent on the mining sector and agricultural sector (5> of

G4) with the products to be e*ported mainly to the ast Asian market.

Australia;s average G4 growth rate for the period 5?!5D!!! was 3.+> annually. Growth peaked during

the 5?!s followed by the 5?&!s and the 5?!s. @y contrast the late 5?5!s#early 5?!s the 5?3!s the

5?=!s and early 5??!s were marked by financial crises. 0rom the early 5?!s onwards the Australian

economy has undergone a continuing economic liberalisation. $n 5?3 under rime 2inister  @ob Eawke

 but mainly driven by 'reasurer aul Feating the Australian dollar was floated and financial deregulation 

was undertaken.

  Annual percentage growth in real (chain volume) G4 per capita since 5?<!

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'he early 5??!s recession came swiftly after the @lack 2onday of /ctober 5?= resulting from a stock

collapse of unprecedented sie caused the 4ow Jones $ndustrial Average to fall by .<>. 'his collapse

larger than the stock market crash of 5?? was handled effectively by the global economy and the stock

market began to 6uickly recover. Eowever in ,orth America the lumbering savings and loans industry

was facing decline which eventually led to a savings and loan crisis which compromised the wellbeing of

millions of Americans. 'he following recession thus impacted the many countries closely linked to the

:nited -tates including Australia. aul Feating who was rime 2inister  at the time famously referred to

it as Hthe recession that Australia had to have.HI3& 4uring the recession G4 fell by 5.= per cent

employment by 3.+ per cent and the unemployment rate rose to 5!. per cent.I3< 4espite this there was a

 beneficial reduction in inflation.

2.2 Economy analysis of Jaan: 'he economy of Japan is the third largest in the world by nominal

G4 the fourth largest by  purchasing power parity and is the world;s second largest developed

economy. According to the $nternational 2onetary 0und the country;s per capita G4 () was at

%3<?? the nd7highest. Japan is a member of G=. 'he Japanese economy is forecasted by the Kuarterly

'ankan survey of business sentiment conducted by the @ank of Japan.

4ue to a volatile currency e*change rate Japan;s G4 as measured in dollars fluctuates widely. Accounting

for these fluctuations through use of the Atlas method Japan is estimated to have a G4 per capita of

around %3+?!. $n the three decades of economic development following 5?<! Japan ignored defense

spending in favor of economic growth thus allowing for a rapid economic growth referred to as

the Japanese post7war economic miracle. @y the guidance of  2inistry of conomy 'rade and $ndustry

 with average growth rates of 5!> in the 5?<!s &> in the 5?=!s and +> in the 5?!s Japan was able to

establish and maintain itself as the world;s second largest economy from 5?= until !5! when it was

supplanted by the eople;s 8epublic of China. @y 5??! income per capita in Japan e6ualed or surpassed

that in most countries in the est.

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  G4 er capita of Japan since 5?<!

Eowever in the second half of the 5?!s rising stock and real estate prices caused the economic bubble to

the Japanese economy by @ank of Japan. 'he economic bubble came to an abrupt end as the 'okyo -tock

*change crashed in 5??!D? and real estate prices peaked in 5??5. Growth in Japan throughout the 5??!s

at 5.&> was slower than growth in other maor developed economies giving rise to the term Lost 4ecade.

 ,onetheless G4 per capita growth from !!57!5! has still managed to outpace urope and the :nited

-tates

!.0 Analysis of Industry:

A market  assessment tool designed to provide  a  business with an idea of the comple*ity of a particularindustry. $ndustry analysis involves reviewing the economic political and market factors that influence the

way the industry develops. 2aor factors can include the  power  wielded by suppliers and buyers the

condition of competitors and the likelihood of new market entrants. 'hat is why Australia Japan Cable itMs

very essential to do industry analysis before taking this proect. 'hrough the orterMs five forces model we

will show the details of industry analysis.

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!.1 "orter#s $ive $orces %odel 

orterMs 0ive 0orces framework points out that the state of competition in any industry depends on five

competitive forcesN

5)  'hreat of entrants

)  'hreat of substitutes

3)  ower of suppliers

+)  ower of buyers and

&)  8ivalry among industryMs firms.

Eowever  a companyMs success in an industry depends on how it is related to that industry and how the

industry is structured. (orter 5?!).

1.) &hreat from ne' entrants:

A. (esire to )ain mar*et share 

orter indicates that new entrants bring with them new capacity and the desire to gain market share. ,ew

entrants bring new capacity and the desire to gain market share. 'his desire puts pressure on costs prices

and the rate of investment that is necessary to compete. 'hreat of entry depends on two factorsN the height

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of entry barriers and the incumbentsM reaction to new entrants. According to Australia7 Japan cable the

maor entry barriers areN

 atents  Large capital re6uirements

 conomies of scale  Governments regulations

 roduct differentiation  redatory behavior by unions

 /wnership of resources

+.  ,i)h caital re-uirements: 

$tMs 6uite normal that in cable industry a company needs huge investment. 'here is a huge capital

re6uirements positively affect communication sector because it limits the competition.

C. &ime to learn for ne' cometitors:

 Eigh learning curves positively affect profits for communication. hen the learning curve is high new

competitors must spend time and money studying the market before they can effectively compete.

2.) ivalry amon) E/istin) $irms: 

2a)or Cable companies are relatively e6ual in sie( power and capabilities. 'his increases

the intensity of rivalry which can manifest itself in a price war if a competitor tries toinfluence prices. @ut right now there is not much rivalry in AJC as all the companies in

association with 3orld are working together as a new conglomerate.

3.) &hreat from substitute roducts: 

3ith the number of cable companies already in the industry( new entrants would find it

very difficult to make a strong showing in the market. -ubstitute has low impact in this

industry because of the many business opportunities that e*ist.

4. +ar)ainin) o'er of buyers:

owerful buyers have the ability to reduce prices( demand better 6uality or more service

and play industry participants off against each other. AJC Company is in  powerful position

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to bargain prices demand better 6uality or additional service. AJC companies seek to obtain

rights to invest in e*ploration and production areas internationally. 'hese rights are

ac6uired through buying a percentage of another companyMs right or through participating in

licensing rounds.

5.) Bargaining power of the supplier:

owerful suppliers affect the market through charging higher prices( limiting  production and

 by integration. 'here are a less number of substitute inputs available against cable so here

 bargaining AJC is moderate and supplier AJC has higher  bargaining power against them.

'echnology 1e6uipment are mainly supplied by the specific companies and by themselves.

!.2 "E&E Analysis

-' analysis stands for Holitical conomic -ocial and 'echnological analysisH and describes a

framework of macro7environmental factors used in the environmental scanning component of strategic

management. -ome analysts added Legal and rearranged the mnemonic to slept inserting nvironmental

factors e*panded it to -'L or -'L which is popular in the :F. Eere we will use -'L

Analysis to describe macro7environmental factors of Australia.

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"olitical

'hese factors determine the e*tent to which a government may influence the economy or a certain industry.

According to the Australian government it is seriously considering a substantial investment in the proect

 but as the submarine cables are part of the network which is replacing satellites as the preferred means of

global communication the government is very much interested in the continuation of the proect

2oreover it will provide a huge cash flow in budget that can help them to take necessary steps on the

 proect that the government wants to implement.

 

Economic

'his factor takes into consideration all events that affect the internal and e*ternal economic environment.

'he internal or micro7economic events relate to the proect viability and internal soundness of the

 proect .Australia communication systems are very good in terms of business applications. $n comparison to

 pager usage within the :- mobile phones (cell phones) have become very common and affordable among

teenagers business people and families alike. $n -eptember of !!! there were &5 licensed

telecommunication carriers operating within Australia. $n June of 5??? there were around &! service

 providers over &! of these being $nternet service providers ($-;s) throughout Australia. -o not only is

cell phone usage $nternet access is also common throughout Australia. -o the proect of submarine cable

would be a profitable one. $mproved broadband connectivity is also e*pected to increase the fre6uency and

6uality of communications among the countries in the region facilitating a growth in trade related services

such as tourism and back7office functions. A recent orld @ank study indicates that a 5!> increase in

 broadband penetration results in a 5.3> increase in gross domestic product (G4) growth in a country.

 

ocial

'he proect will contribute to the socio7economic development of the region through the e*pansion of inter7

Australia and apan trade facilitated by lower costs and better communication. 'he e*pected increase in

employment and income for the regions will help to reduce poverty and lead to sustainable development

Additionally the proect will help in breaking the barriers of social and geographical isolation and assist the

 population in its 6uest to access information and continued education.

 

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&echnolo)ical

'hese factors pertain to innovations in technology that may affect the operations of the industry and the

market favorably or unfavorably. 'his refers to automation research and development and the amount of

technological awareness that a market possesses. As the telecom sector is highly evolving (in 5???) there

is always technology risk associated with such proects. 'here is a possibility of bigger and better

technology (which would handle higher and much bandwidth) in such an environment.

 

Environmental

'hese factors include all those that influence or are determined by the surrounding environment. 4amage to

submarine cables can have a maor impact on the Australian economy protection of the security of

submarine cables is critical. 4amage to subsea cables is mostly accidental caused by fishing trawlers

anchors mining and dredging. Eowever there are growing fears internationally of the risk of sabotage to

cables. 'here are over !! submarine cables buried in the ocean worldwide connecting the global

telecommunications network and the global digital economy. @ehind the abstract virtual cloud of

cyberspace is a very real physical infrastructure with some surprising vulnerabilities. 2an7made causes

account for the overwhelming maority of damage caused to cables with =! per cent of all cable faults

caused by fishing and anchoring in depths of less than !! meters. ,atural disasters such as the earth6uake

and tsunami in Japan can also sever cables.

 

e)al

'here are certain laws that affect the business environment in a certain country while there are certain

 policies that companies maintain for themselves. Legal analysis takes into account both of these angles and

then charts out the strategies in light of these legislations. As there is two countries involved in this cable

 proect there is a chance that some legal problem may appear. 0or this reason the consortium signed

memoranda of understanding (2/:) with the two countriesM governments. $n some countries governments

only gave out permits for paths where cables and landing stations already e*isted which meant dealing

with the owners of e*isting landing stations. After obtaining a permit and access to a landing station

system owners had to get clearance from local fishing and government authorities. ith a desire not to

disrupt fishing activities authorities granted clearances for only short periods often once or twice a year.

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3.0 Analysis of the Comany:

3.1 4O& analysis

-/' Analysis is a useful techni6ue for understanding -trengths and eaknesses and for identifying both

the /pportunities open to us and the 'hreats we face. A business analysis of Australia Japan Cable

submarine telecommunication cable system focusing on the strengths weaknesses opportunities and

threats (-/') faced by the company.

tren)ths

'elstra has a strong network of infrastructure which supports its operations. 'he strong network

infrastructure backs the business operations and provides 'elstra with a two7edge sorrow on

competition with other companies. $n the retail business board 'elstra made a record about its

growing strongly. 'he operation had a better performance due to the 'elstra;s strong retail broadband

 performance. $n the telecommunications market of Australian 'elstra is one of the most meaningful

companies. 'elstra launch new services and improves its competition which result from its strong

market position.

4ea*nesses

-tockholders; faith and its brand worth are damaged for the weak relationship between the 'elstra and

regulatory bodies.

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Oortunities

$n the telecom market of China the operations business is e*panded. $n addition the internet users of China

have reached ? million up at a high of +>. 'he internet penetration of China users is at .<> that is

very low which has left a growth room. Chinese internet market can stimulate company;s growth seeingfrom itMs e*panding at present.

&hreats

$n Australian the mobile market has saturated. 'elstra got amount of revenues from the Australian mobile

market at the same time operating performance of 'elstra could be influenced in near term. Eowever in

the future years the regulatory environment could have an impact on the 'elstra;s operation performance

3.2 atio analysis

8atio analysis is a tool used by individuals to conduct a 6uantitative analysis of information in a company;s

financial statements and the economy to udge the performance of the company. Eere we have analyed

ratio of Australia Japan Cable proectMs original sponsor group ('elstra Japan 'elecom and 'eleglobe) to

evaluate various aspects of companyMs operating and financial performance such as its efficiency li6uidity

 profitability and solvency during the year 5??.

 Y!" 1998 Telstra Japan Telecom Teleglobe

#urrent "atio 0.527803959 0.777065527 0.961997828

$ross %argin 42.91& 16.78& 19.17&

'ro(t %argin 17.36& 1.96& 2.53&

*perating %argin 0.429103435 0.167789541 0.191651969

"*! 0.11348424 0.01437662 0.007279499

"* 0.271114988 0.0305 0.010351468

+e,t ratio 0.581416575 0.528635399 0.296766548

-ie/ asset * 0.787809887 0.988895939 0.338777136

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3.2.1 Current atio:

'he current ratio is a li6uidity ratio that measures a company;s ability to pay short7term and long7term 

obligations. 'o gauge this ability the current ratio considers the total assets of a company (both li6uid and

illi6uid) relative to that companyMs total liabilities.

Interretation: Current ratio of 'elstra Japan telecom and 'eleglobe is under 5 which indicates their

liabilities are greater than their assets but 'eleglobeMs financial health is good compared to 'elstra and Japan

'elecom.

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3.2.2 5ross %ar)in:

'he gross margin represents the percent of total sales revenue that the company retains after incurring the

direct costs associated with producing the goods and services sold by a company. 'he higher the

 percentage the more the company retains on each dollar of sales to service its other costs and obligations.

Interretation: Euge gross margin indicates that 'elstra has competitive edge over rivals that maintain

higher profit margins than Japan telecom and 'eleglobe. 'elstra retains more on each dollar of sales to

service its other costs and obligations.

3.2.! "rofit %ar)in:

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rofit margins are e*pressed as a percentage and in effect measure how much out of every dollar of sales a

company actually keeps in earnings.

Interretation: ,et profit margin is mostly used to compare company;s results over time. ,et profit

margin measures how much of each dollar earned by the company is translated into profits. -o here we can

say that 'elstra has proper chance to better over other than Japan telecom and 'eleglobe.

3.2.3 eturn on Asset:

An indicator of how profitable a company is relative to its total assets. 8/A gives an idea as to how

efficient management is at using its assets to generate earnings. Calculated by dividing a company;s annual

earnings by its total assets

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Interretation: 8eturn on asset gives an idea as to how efficient management is at using its assets to

generate net income. Eere 'elstraMs 8/A is much higher Japan 'elecom and 'eleglobe. 'elstra is profitable

relative to its total asset compared to Japan 'elecom and 'eleglobe.

3.2.6 eturn on E-uity:

8eturn on e6uity measures a corporation;s profitability by revealing how much profit a company generates

with the money shareholders have invested.

Interretation: 'his ratio indicates how profitable a company is by comparing its net income to its average

shareholders; e6uity. 8eturn on e6uity indicates the return on ownerMs investment in this term 'elstra data is

very positive and optimistic for company. 0rom the above graph we can say that 'elstraMs management is

more efficient in utiliing its e6uity base and better return is to investors than Japan 'elecom and 'eleglobe

3.2.7 (ebt ratio:

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'he debt ratio is defined as the ratio of total long7term and short7term D debt to total assets e*pressed as a

decimal or percentage. $t can be interpreted as the proportion of a companyMs assets that are financed by

debt.

InterretationN 4ebt ratio is the ratio of total liabilities of a business to its total assets. 4ebt ratio ranges

from !.!! to 5.!!. Lower value of debt ratio is favorable and a higher value indicates that higher portion of

companyMs assets is claimed by its creditors. -o we can say that 'elstra and Japan telecom are more

leveraged company compared to 'eleglobe.

3.2.8 $i/ed Asset &urnover ratio:

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'he fi*ed asset turnover ratio compares net sales to net fi*ed assets. A high ratio indicates that a business is

doing an effective ob of generating sales with a relatively small amount of fi*ed assets outsourcing work

to avoid investing in fi*ed assets and selling off e*cess fi*ed asset capacity

Interretation: 'he fi*ed7asset turnover ratio measures a company;s ability to generate net sales from

fi*ed7asset investments 7 specifically property plant and e6uipment (1). Eere Japan 'elecomMs fi*ed

asset turnover is higher than that of others which indicates the company has been more effective in usingthe investment in fi*ed assets to generate revenues.

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3.! (u"ont Analysis

4uont analysis e*amines the return on e6uity analying profit margin total asset turnover and financial

leverage.  e are using 4uont method for Australia Japan Cable proect to know how much companyMs

assets generate sales  or cash  and how 'elstra Japan 'elecom and 'eleglobe will uses debt  to produce

incremental returns.

:sing these three factors we could know efficiently and determine where the companies are weak or strong

of the business to look AJC proect.

 "articulars $ormula &elstra

Jaan

&elecom

 

&ele)lobe

rofit 2argin ,et $ncome#-ales

!.5=3<33=+ !.!5?&=!!?? 7!.!&=?+

'A 'urnover -ales# 'otalAssets

!.<&3&+!33 !.=3+<5=3 !.=?<3+33

8/A

rofit2arginO 'A'urnover 

!.553+++ !.!5+3=<< 7!.!!==?+??

6uity 2ultiplier 

'otal Assets#Common6uity

.3?!5!!35.55& 5.+!!?

8/8/AO 6uity2ultiplier 

=.55> 3.!&> 75.!+>

"articulars &elstra Jaan &elecom &ele)lobe

'otal 8evenues (in millions) 5!=+5 355= 5=!5

 ,et $ncome#Loss (in millions) 5<& <5 7+3

'otal Assets (in millions) 5<+3+ ++3 &?!=

'otal -hareholders; 6uity (in

millions)

<=? !!! +5&+

Interretation: 0rom the above calculation we can find that 'elstraMs 8/ (=.55>) is higher than Japan

telecom and 'eleglobe in 5??. 'his is why the total net income is higher than others. @oth 6uity

multiplier and profit margin of 'elstra is higher than Japan telecom and 'eleglobe. 'otal asset turnover of

'elstra is lower than Japan telecom but much higher than 'eleglobe.

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3.3 is* Analysis:

8isk analysis is a techni6ue to identify and assess factors that may eopardie the success of a proect or

achieving a goal. 'his techni6ue also helps to define preventive measures to reduce the probability of these

factors from occurring and identify countermeasures to successfully deal with these constraints when they

develop to avert possible negative effects on the competitiveness of the company.

3.3.1 Country ris*:

'he country risk assessment has been made for both Australia and Japan by using the $nternational Country

8isk Guide ($C8G) 2ethodology for Australia Japan Cable proect evaluation. 'he $nternational Country

8isk Guide ($C8G) rating comprises variables in three subcategories of riskN political financial and

economic. A separate inde* is created for each of the subcategories. 'he olitical 8isk inde* is based on

5!! points 0inancial 8isk on &! points and conomic 8isk on &! points. 'he total points from the three

indices are divided by two to produce the weights for inclusion in the composite country risk score. 'he

composite scores ranging from ero to 5!! are then broken into categories from 9ery Low 8isk (! to 5!!

 points) to 9ery Eigh 8isk (ero to +?.? points) and Low risk (=!.! to =?.?). All the variables 1 sub

components are ranked based on assumption as those data were unavailable at free of cost.

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Country ris* estimation of Australia and Jaan:

&he "olitical is* atin):

'he risk that an investment;s returns could suffer as a result of political changes or instability in a country.

$nstability affecting investment returns could stem from a change in government legislative bodies other

foreign policy makers or military control. $n 5??!s under governments led for the most part by the long7

ruling Liberal 4emocratic arty Japan e*perienced a series of substantial changes in its political system

changes that together add up to what may call a comprehensive overhaul.

$n 5??!s Australia faced early recession. 'he Government of Australia promised economic recovery for

5??5 and launched a series of asset sales to increase revenue. G4 sank unemployment rose revenue

collapsed and welfare payments surged. 'ill then the country is doing good.

Political RiskComponent

Composent Sub-sub componentHightestScore

Score(Australia)

 Score(Japan)

Govt Stabilit $ot nit 4 4 3

  egislatie trangth 4 3 3

  'opular upport 4 3 3

  Sub-Total !" !# $SocioeconomicCon%ition ne%plo%ent 4 3 3

  #onsu%er on(/ane 4 3 3  'oert 4 3.5 3

  Sub-total !" $&' $

nvestment Prole#ontratai,ilitproportion 4 3 3

  'ro(t "epatriation 4 3 3

  'a%ent /elas 4 3 3

  Sub-total !" $ $

nternal Con*ict #iil ar#oup threat 4 3.5 3

  erroris% 'olitialiolene 4 3.5 3.5

  #iil +isor/er 4 4 3.5

  Sub-total !" !! !#

+,ternal Con*ict ar 4 4 4

  #rossBor/er onit 4 4 3

  -oreign 'ressure 4 3 3

  Sub-total !" !! !#

Corruption   6 4 4

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ilitar in politics   6 3 3

Religious tension   6 5 5

.a/ an% or%er   6 4 5

+thnic tension   6 5 2

0emocratic

accoutibil   6 4 51ureaucrac 2ualit   4 3 3

  Total3 !## 45&' 46

Economic is*:

'his risk refers to a country;s ability to pay back its debts. A country with stable finances and a stronger

economy should provide more reliable investments than a country with weaker finances or an unsound

economy.

Australia and Japan both the countryMs economic situation was not so good. JapanMs stock

e*change crashed in 5??! and Australia faced early recession in 5??!s. Eowever right now both countryMs

market is bit more stable and friendly.

(Australia)

 (Japan)

The economic risk rating  

Components Points Points

$+' per ;ea/ 5 4 3.5"eal $+' $rowth 10 8.5 6.5

!nnual <nation "ate 10 9 9

Bu/get ,alane as a & of $+' 10 8.5 8

#urrent !ount as a & of $+' 15 8.5 8.5

Total3 '# 75&' 7'&'

$inancial is*:

0inancial risk is the risk that a government will default or miss a payment on its national debt. Country

financial risk is important in determining the value of a currency. 0or Australia and Japan now the

financial risk is improving we could see from the rating of financial risk. *change rate of currency is now

get more stability.

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6.0 tatement of the roblem

'he Australia Japan cable (AJ) proect is a %&! million and 5&!!7Filometer submarine

telecommunication cable system. 'o build the system they need to choose e6uipment supplier hire cable

ships and assess to landing station right of way permits and harbor clearance.

'he maor problem with valuating the proect lies as the following 6uestions7

Eow market risk is maor concern for fast changing telecom marketQ

Eow can mitigate risk if there is a proect delayQ

hat discount rate should be used to evaluate a proect that involves multiple countriesQ

hat is the optimal capital structure for financing this proect and how will the syndicate raise the

necessary debtQ

hat type of financing would be used to form AJC by 'elstraQ hy 'elstra used such financing

strategyQ

3hat problems 'elstra and its sponsors had in mind while considering -CC, not the right

communication system between Australia Japan and the :.-.Q 3hat kind of problems would arise if any of the sponsors want to e*it the businessQ Eow the

 problems would be handledQ

7.0Alternative courses of action

K5N hat discount rate should be used to evaluate a proect that involves multiple countriesQ

$n this case it is necessary to determine the cost of capital for the average AJC proect. e assume the

 premium for inflation as ?.5> according the economic trends and risk free rate is &>. As we determined

the country risk we found Australia and Japan is a country of RLow 8iskM for such type of proect. -o we

may assign a low value of risk premium. eMll consider it as 5>.

'he discount ratePrisk free rate" inflation premium" risk premium

Eere discount rateP&.!!> " ?.5> " 5> P 16.129

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KN Eow can mitigate risk if there is a proect delayQ

reliminary estimate to build the system was %&! million but if there was a maor completion delay

(environmental approvals and other permitting) system would be %&<= million. -o the cost of delay would

 be %+= million. 'o mitigate completion delay they need to incorporate procedures that would allow AJC to

draw continues flow of funds.

K3N hat is the optimal capital structure for financing this proect and how will the syndicate raise the

necessary debtQ

0or target capital structure 'elstra envisioned two debt tranches7

'ranche AN 'his secured and rapid (within & years) with presale commitments to purchase capacity.

'ranche A presales up to %33= million.

'ranche @N 'his repaid from future sales of capacity to other parties (within & years). 'ranche @ sales %5+&

million.

5& > e6uity and &> of investment financed by bank lends guaranteed by presold capacity to sponsors and

other carriers.

K+N Eow market risk is maor concern for fast changing telecom marketQ

2arket risk was maor concern for AJC. 'o mitigate market risk they need re7sales capacity contracts

from highly rated companies covering appro*imately #3rd  of total proect cost Collapsed ring

configuration (lower cost) and Low cost capacity across ,orth acific.

K&N hat type of financing would be used to form AJC by 'elstraQ hy 'elstra used such

financing strategyQ

'elstra wanted to use proect finance as a way to conserve scarce capital as it wanted to limit the amount of

e6uity they had to invest in the pro)ect. 0or 'elstra itself it wanted to hold around +!> of the e6uity to

ensure that it had a significant role in running the company. At the same time it wanted to leave enough

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e6uity so that its partners would have meaningful e6uity positions and large enough shares to ustify board

representation.

K<N 3hat problems 'elstra and its sponsors had in mind while considering -CC, not the

right communication system between Australia Japan and the :.-.Q

$n mid75??= the sponsors of the -outhern Cross Cable ,etwork (-CC,) were building a full

loop link between Australia and the :.-. 'hen 'elstra and its sponsors suggested modifying

the proect by removing the parallel path direct to the :.-.A. creating a link from Australia to

Japan( and ac6uiring capacity across the ,orth acific. @ut the sponsors of the -outhern

Cross proect were not persuaded by their proposal.

K=N 3hat kind of problems would arise if any of the sponsors want to e*it the businessQ

Eow the problems would be handledQ

8esolving when and how sponsors could e*it the business was clearly an issue to be

considered. As a private deal sponsors will have li6uidity concerns which meant we needed a

 process for valuing and selling shares. @ut having such a process in place worries bankers who

7make credit decisions based on the composition of the sponsor group. 'hey agree to lend

 because the purchase commitments come from high7rated sponsors and could get very

concerned if low7rated sponsor became owners.

8.0 Analysis of each alternative:

8.1 aluation:

$f the proect is taken then we need to invest %&! million appro*imately. All system cost construction

contingency and other development cost are included in the initial investment. e tried to minimie thecost from estimated by making critical udgment. After establishing all facility to produce we can increase

sales by &> yearly. e are hoping that variable cost will be &> of sales. e have to maintain %& million

working capital. e have used straight line method for depreciation. @ecause we donMt know which

method will be acceptable by Australia ta* authority. e have taken all above factors under consideration

and then we calculated the ,9. 'he value of ,9 comes %! million. 'he proect $88 is 5&.=&>. -o if

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the cost of capital is 5&.=&> then we will have neither profit nor loss. e will have profit in the proect. 0or

re7assurance we ran 5!!!! trials in 2onte7carlo -imulation. 'he Assumptions are given belowN

;et "resent alue:

'he

simulation shows that the mean ,9 is %& million. $t is clearly indication the profit of the proect. 'he

risk of the proect is low. -o the simulation shows that the low riskiness of the proect.

imulation:

'he ,9 is negatively =.=> sensitive to the Cost of Capital. $f the cost of capital goes up the ,9will go down. Also the ,9 is negative to annual fi*ed cost and variable cost. 'he ,9 is also +.3>

 positively sensitive to the sales growth rate.

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Internal ate of eturn:

After running 5!!!! simulations we find out the $88 is almost closer to previous $88. 'he mean $88 is

5&.<?> where previous $88 5&.=&>. 'he riskiness of $88 is ?.??>. $t is 6uite medium risky

investment to the conte*t of $88.

ensitivity Analysis:  'he $88 is

 positively ?.> sensitive to the

-ales growth rate. $f the sales goes

up the $88 will goes up by .?

for every 5> growth. 'he $88 is

also negatively sensitive to the

variable cost annual fi*ed cost. $f 

variable cost and annual fi*ed cost

goes up the $88 will go down.

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%oderate Internal ate of eturn:

$tMs almost similar to the $88. 'he 2$88 is here 5&.+5>. $n every case for 5!!!! times it will be 5&.3!>.

'he mean vale is also 5&.3!>. 'he 2$88 is &.<> risky which indicates low risk.

ensitivity Analysis:

'he 2$88 is mostly sensitive to cost of capital sensitivity. 2$88 is positively 3!> sensitive to the cost of

capital rate. $t indicates if cost of capital rate increased then the 2$88 will go up. Also if sales growth rate

increased then the 2$88 will goes up by !.>. $f the variable cost goes up the 2$88 will decrease by

=.&> and if the annual fi*ed cost goes up the 2$88 will decrease by 5.=>.

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-o considering all the assumption we should take the proect. @ecause all the assumption is showing that

Australia proect is money earning proect and the risk of the proect is low e*cept $88 which will

contribute a fat amount to the income statement.

8.2 eal Otion Consideration

'he value of distinct proect timing decisions becomes more apparent through a real options approach

'here is a possibility of upgrading the capacity (! Gbit#s) after & years of operation. 'he managers of the

 proect can consider the possibility of upgrading the capacity (! Gbit#s) as a real option. $t is e*pected that

the benefits can be realied for & years. e had to value this real option and this value would be added to

the ,9 of the proect. $f the value of the real option is negative then the managers will not e*ercise theoption. 'he amount of cost is %&! million. ,et cash flow each year is estimated as follows7

Probabilit9et cash *o/each ear

0.1 12000000

0.2 18000000

0.35 23000000

0.25 30000000

0.1 40000000

 

'he valuation of the real option is done by using the @lack7-chole model. 0or that we had to assume some

elements they are

8isk free rate (8f) &>

e assume cost of capital to be 5&.5 >. (:sing risk adusted discount rate)

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:ption pricingP; o< cash *o/s (S) 69350312.24 Current Asset ;alue

nvestment (=) 50000000 +,ercise (Strike) Price

Time (T) 4 Time to aturit (>ears)

Risk <ree rate (R<) 0.05 Riskless nterest Rate (? p&a&)

 

0.427882826 ;olatilit (? p&a&)

 

%! 1.043878154

%" 0.188112502

9(%!) 0.851729117

9(%") 0.57460577

C 35545309.47

&he call otion value is < = !6636!0>

-ince the real option price is positive so it will increase the firmMs value. Eence the option should be

taken.

'herefore 'rue ,9P'raditional ,9 "real option value

  P%! million " %3&.&& million

  P%&&.&& millionB 'herefore we should take the proect. 'hat proect will be

 profitable for the company.

Eere with the basic Cash 0low Analysis we found the ,9 positive (%! million) and $88 5&.=&> where

the cost of capital is 5&.5>.

-o with e*ercising the real option the proect can be accepted for investment.

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?.0 ecommendation:

4uring the feasible study of the proect it was found out that there was a great demand of capacity in future.

'herefore the proect should be taken in no time while there still is a little number of competitors./perational risks (delays due to suppliers landing stations etc) may be mitigated with the allocation of

contingency CAS (5!> was used in this case). Governance risks can be mitigated by choosing sponsors

 based on companyMs debt rating. 'he type of risks that prevail must be mitigated before starting the

construction of the AJC Company. 4ifferent scenarios have been anglicied during the calculation of free

cash flows and its element. ven $n the worst case scenario the proect is still attractive meaning the

 proect got positive ,9. -o without any doubt Australia Japan Cable proect must be taken by the

investors. -ource of risk of this kind of proects areN 2arket risks operational risks governance risks.

2arket risks can be mitigated by selling capacity in advance and e*ploiting opportunities of deficit of

supply. As the real option value is positive so it will increase the firmMs value and therefore AJC should

consider the real option.

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A""E;(ICE