DOW CHEMICALâ€™S BID FOR THE PRIVATIZATION OF PBB IN ARGENTINA Case Solution
Potential Risk associated with the Project and their treatment
It can be seen from the detailed analysis of the case that the company has several risks attached with this acquisition, which mainly include the currency risk as well as the exchange rate risk. The presence of these risks could create damaging effects for the viability of the project. However, it can be analyze from the case that with the convertibility law imposed by the Argentinean government, the risk relating to the currency has been substantially subsided. In the case when this exchange rate risk rises significantly, the company can make use of certain hedging alternatives in order to minimize that risk, which includes the entrance in forward market as well as certain other swap options. Thus, it can be seen that the risk associated with the exchange rate risk is substantially low because it could be minimized using various hedging tools further and should not be given a detailed consideration in order to compute the valuation of PBB.
Country Risk its Impact and its adjustment
As far as the other risk is concerned, it can be seen from the Exhibit 12 of the case that the country risk is relatively very high, which strongly suggests that the company must account for this risk before computing the real worth of PBB. This can be done by using the CAPM approach. The risk premium should comprise of both the market risk premium as well as the country risk premium. The case provides discount factor of 8% to 10%. The risk free rate as well as the market risk premium for the given company could be computed using Exhibit 12 of the case, which illustrates that the risk free rate has been very consistent for a longer period of time to about 5%. Moreover, the market risk premium, with the help of historical information, is estimated to be 5% as well. Thus, by using all the given information, the beta is computed to about 0.6 to 0.1. Other computation is related to the country risk premium, which could be computed using the value of Bond Yield provided in the case and the equity market volatility. From the analysis of the case, the bond yield is computed to be 6%, which is the appropriate measure computed with help of the dotted line in Exhibit 12 of the case. Meanwhile for the volatility factor, it can be seen that the equity markets are significantly more volatile than the bond market, which has been found to be around 1.5 times in the developing market. The country risk premium in the given case is thus estimated to be about 9%. Now, with the help of the above elements, the discount rate for the given case is computed with the help of following CAPM formula:
Discount Rate = Risk Free Rate + (Market Risk Premium + Country Risk Premium) * Beta
The worst as well as the best scenarios are computed by inputting values in the formula above; it can be seen that under the best case, the discount rate is computed to about 13.4% whereas under the worst case scenario, the discount rate is computed to about 19%, which could provide a range of values for the possible valuation.
Â What would you bid for this project?
The case provides minimum bid for the company to be $150 million. However, using the discounted cash flow method for each of the three stages, as described in the case, the value computed for the first stage in the best as well as in the worst case is $ 464 million and $ 320 million, these values are for the entire stake in the company. By considering the 51% stake, the value comes out to be $ 236.8 million, which should be the optimal price that should be considered for the bid of this project……………..
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