Background Of Foreign Direct Investment

Published Date: 02 Nov 2017

Net present value ('NPV') of a project is the sum of the discounted cash flows less the initial investment. The advantage of using NPV method in evaluating a project is that it focuses on the effect of a project towards the shareholders' wealth. The rule of thumb in using the NPV method is all projects with a positive NPV will be accepted. In other word, all projects that will increase shareholders' wealth will be undertaken by the company (BPP Publication, 2012).

All available information are:

Teltec PLC is a UK based company wants to expand overseas into Farland.

Average monthly income in Farland is approximately US$400.

3.

The recently elected government in Farland appears to be more stable and is welcoming foreign investment.

4.

Inflation in Farland is currently 40% per annum, but this is expected to fall if the economic policies of the new government become effective.

5.

Estimated future inflation rates are:

YEAR

UK (£)

FARLAND (F)

USE ($)

1

1.5%

30%

2%

2

1.5%

20%

2%

3

2%

10%

3%

4

2%

10%

3%

5

3%

10%

4%

6 and thereafter

4%

10%

4%

6.

Initial set-up costs are:

Land and building

F5,000 million

Plant and equipment

F9,000 million

Working capital

F1,200 million

Tax allowance on plant and equipment at 25% per annum on reducing balance.

Working capital need to be increased in line with inflation in Farland from Year 1 onwards.

7.

Planning zone is for 5 years.

At the end of Year 5, a local company is willing to buy the business for F1,500 million (money term) for the non-current assets net of all taxes (excludes working capital).

8.

Selling price is $600/unit in Year 1 (thereafter expected rise by previous year's inflation rate in USA.

9.

Projected sales volumes are:

YEAR 1

50,000 units

YEAR 2

100,000 units

YEAR 3

120,000 units

YEAR 4

130,000 units

YEAR 5

130,000 units

10.

Variable costs ('VC') of production (all at current prices) are:

Local VC

F42,000/unit

Imported components from UK (VC - £2/unit)

£3.5/unit

Royalty charge (not inflation linked)

£250,000

11.

Fixed costs of production: F120 million

12.

All costs are expected to rise with the current year's inflation level in the relevant country.

13.

Opportunity cost:

Existing export expected to fall by 30%. Current export is 5,000 units/year. Pre-tax contribution of £130/unit at current prices.

14.

Bi-lateral tax treaty:

UK

30%

Farland

20%

15.

Current spot rates are:

$1.78 : £1

F256 : £1

16.

Discount factor: 11.5% (money term)

1.1. THE CALCULATION

1.1.1. Foreign exchange rate

Future Foreign Currency = Current Foreign Currency X 1 + Inflation rate in foreign country

1 + Inflation rate in the country

YEAR 0

YEAR 0

£1.00

F256.00

$1.78

YEAR 1

YEAR 1

£1.00

F327.88

$1.79

FROLLARS = F256.00 X 1.3 = F327.88 ; DOLLARS = $1.78 X 1.02 = $1.79

1.015 1.015

YEAR 2

YEAR 2

£1.00

F387.64

$1.80

FROLLARS = F327.88 X 1.2 = F387.64 ; DOLLARS = $1.79 X 1.02 = $1.80

1.015 1.015

YEAR 3

YEAR 3

£1.00

F418.05

$1.82

FROLLARS = F387.64 X 1.1 = F418.04 ; DOLLARS = $1.80 X 1.03 = $1.82

1.02 1.02

YEAR 4

YEAR 4

£1.00

F450.83

$1.83

FROLLARS = F418.04 X 1.1 = F450.83 ; DOLLARS = $1.82 X 1.03 = $1.84

1.02 1.02

YEAR 5

YEAR 5

£1.00

F481.47

$1.85

FROLLARS = F450.83 X 1.1 = F481.47 ; DOLLARS = $1.84 X 1.04 = $1.86

1.03 1.03

Foreign Exchange Rate Summary

YEARS

POUNDS

FROLLARS

DOLLARS

0

1.00

256.00

1.78

1

1.00

327.88

1.79

2

1.00

387.64

1.80

3

1.00

418.04

1.82

4

1.00

450.83

1.84

5

1.00

481.47

1.86

1.1.2. Tax Depreciation

Tax Relief = Tax Allowance X 20%

Tax Allowance = Cost [OR] WDA X 25%

Written Down Allowance ('WDA') = Cost [OR] WDA - Tax Allowance

YEAR 1

Cost of Plant and Equipment = F9,000 million

Tax Allowance = F9,000 million X 25% = F2,250 million

Tax Relief = F2,250 million X 20% = F450 million

Written Down Allowance = F9,000 million - F2,250 million = F6,750 million

YEAR 2

Tax Allowance = F6,750 million X 25% = F1,687.50 million

Tax Relief = F1,687.50 million X 20% = F337.50 million

Written Down Allowance = F6,750 million - F1,687.50 million = F5,062.50 million

YEAR 3

Tax Allowance = F5,062.50 million X 25% = F1,265.63 million

Tax Relief = F1,265.62 million X 20% = F253.12 million

Written Down Allowance = F5,062.50 million - F1,265.63 million = F3,796.87 million

YEAR 4

Tax Allowance = F3,796.87 million X 25% = F949.22 million

Tax Relief = F949.22 million X 20% = F189.84 million

Written Down Allowance = F3,796.87 million - F949.22 million = F2,847.65 million

YEAR 5

Tax Allowance = F2,847.65 million X 25% = F711.91 million

Tax Relief = F711.91 million X 20% = F142.38 million

Written Down Allowance = F2,847.65 million - F711.91 million = F2,135.74 million

Tax Depreciation Summary

YEAR

DESCRIPTION

COST (mF)

TAX ALLOWANCE

TAX RELIEF

@ 20%

0

Plant & Equipment

9,000.00

1

@ 25%

2,250.00

2,250.00

450.00

WDA

6,750.00

2

@ 25%

1,687.50

1,687.50

337.50

WDA

5,062.50

3

@ 25%

1,265.63

1,265.63

253.13

WDA

3,796.87

4

@ 25%

949.23

949.23

189.85

WDA

2,847.64

5

@ 25%

711.91

711.91

142.38

WDA

2,135.73

1.1.3. Working Capital

Working Capital = Amount X (1 + Current Inflation Rate)

Differences = Current Working Capital - Previous Working Capital

YEAR 0

Working Capital = F1,200 million

YEAR 1

Working Capital = F1,200 million X 1.3 = F1,560 million

Differences = F1,560 million - F1,200 million = F360 million

YEAR 2

Working Capital = F1,560 million X 1.2 = F1,872 million

Differences = F1,872 million - F1,560 million = F312 million

YEAR 3

Working Capital = F1,872 million X 1.1 = F2,059.20 million

Differences = F2,059.20 million - F1,872 million = F187.20 million

YEAR 4

Working Capital = F2,059.20 million X 1.1 = F2,265.12 million

Differences = F2,265.12 million - F2,059.20 million = F205.92 million

YEAR 5

Working Capital = F2,265.12 million

Working capital of F2,265.12 million will be added in the NPV calculation in year 5.

Working Capital Summary

YEAR

WORKING CAPITAL (mF)

DIFFERENCES (mF)

0

1,200.00

1,200.00

1

1,560.00

360.00

2

1,872.00

312.00

3

2,059.20

187.20

4

2,265.12

205.92

5

0

2,265.12

1.1.4. Sales

Sales ($) = Quantities X (Amount per unit X Previous Inflation Rate for Year 2 onwards)

Sales (mF) = Sales ($) / Forex Rate ($ to £) X Forex Rate (£ to F) /1,000,000

YEAR 1

Sales ($) = 50,000 units X $600 = $30,000,000

Sales (mF) = $30,000,000 / $1.79 X F327.88 / 1,000,000 = F5,495.20 million

YEAR 2

Sales ($) = 100,000 units X $600 X 1.02 = $61,200,000

Sales (mF) = $61,200,000 / $1.80 X F387.64 / 1,000,000 = F13,179.76 million

YEAR 3

Sales ($) = 120,000 units X $600 X 1.02 X 1.02 = $74,908,800

Sales (mF) = $74,908,800 / $1.82 X F418.04 / 1,000,000 = F17,205.98 million

YEAR 4

Sales ($) = 130,000 units X $600 X 1.02 X 1.02 X 1.03 = $83,585,736

Sales (mF) = $83,585,736 / $1.84 X F450.83 / 1,000,000 = F20,498.87 million

YEAR 5

Sales ($) = 130,000 units X $600 X 1.02 X 1.02 X 1.03 X 1.03 = $86,093,308.08

Sales (mF) = $86,093,308.08 / $1.86 X F481.47 / 1,000,000 = F22,285.67 million

Sales Summary

YEARS

QUANTITIES

AMOUNT/UNIT

TOTAL ($)

TOTAL (mF)

1

50,000

600.00

30,000,000.00

5,495.20

2

100,000

612.00

61,200,000.00

13,179.76

3

120,000

624.24

74,908,800.00

17,205.98

4

130,000

642.97

83,585,736.00

20,498.87

5

130,000

662.26

86,093,308.08

22,285.67

1.1.5. Variable Costs ('VC')

Local VC (mF) = (Amount X Cumulative Inflation Rate) X Quantities / 1,000,000

Imports (m£) = (Amount X Cumulative Inflation Rate) X Quantities / 1,000,000

Royalty (m£) = Amount / 1,000,000

YEAR 1

Local VC = F42,000 X 1.3 X 50,000 units / 1,000,000 = F2,730 million

Imports = £1.50 X 1.015 X 50,000 units / 1,000,000 = £0.076 million

Royalty = £250,000 / 1,000,000 = £0.25 million

YEAR 2

Local VC = F42,000 X 1.3 x 1.2 X 100,000 units / 1,000,000 = F6,552 million

Imports = £1.50 X 1.015 x 1.015 X 100,000 units / 1,000,000 = £0.155 million

Royalty = £250,000 / 1,000,000 = £0.25 million

YEAR 3

Local VC = F42,000 X 1.3 x 1.2 X 1.1 X 120,000 units / 1,000,000 = F8,648.64 million

Imports = £1.50 X 1.015 x 1.015 X 1.02 X 120,000 units / 1,000,000 = £0.189 million

Royalty = £250,000 / 1,000,000 = £0.25 million

YEAR 4

Local VC = F42,000 X 1.3 x 1.2 X1.1 X 1.1 X 130,000 units / 1,000,000 = F10,306.30 million

Imports = £1.50 X 1.015 x 1.015 X 1.02 X 1.02 X 130,000 units / 1,000,000

= £0.209 million

Royalty = £250,000 / 1,000,000 = £0.25 million

YEAR 5

Local VC = F42,000 X 1.3 x 1.2 X 1.1 X 1.1 X 1.1 X 130,000 units / 1,000,000

= F11,336.93 million

Imports = £1.50 X 1.015 x 1.015 X 1.02 X 1.02 X 1.03 X 130,000 units / 1,000,000

= £0.215 million

Royalty = £250,000 / 1,000,000 = £0.25 million

Variable Costs Summary

YEARS

LOCAL VC (mF)

IMPORTS (m£)

ROYALTY (m£)

1

2,730.00

0.076

0.25

2

6,552.00

0.155

0.25

3

8,648.64

0.189

0.25

4

10,306.30

0.209

0.25

5

11,336.93

0.215

0.25

1.1.6. Fixed Costs

Fixed Costs = Amount X Current Inflation Rate

YEAR 1

Fixed Costs = F120 million X 1.3 = F156.00 million

YEAR 2

Fixed Costs = F120 million X 1.3 X 1.2 = F187.20 million

YEAR 3

Fixed Costs = F120 million X 1.3 X 1.2 X 1.1 = F205.92 million

YEAR 4

Fixed Costs = F120 million X 1.3 X 1.2 X 1.1 X 1.1 = F226.51 million

YEAR 5

Fixed Costs = F120 million X 1.3 X 1.2 X 1.1 X 1.1 X 1.1 = F249.16 million

Fixed Costs Summary

YEARS

Fixed Costs (mF)

1

156.00

2

187.20

3

205.92

4

226.51

5

249.16

Residual value ('RV') for plant and equipment = (Plant and Equipment / Total Fixed Assets) X RV

= (9,000/14,000) x 1,500 = F964.29

1.1.7. Opportunity Costs

Opportunity Costs = Quantities X (Price per unit X Current Inflation Rate)

YEAR 1

Opportunity Costs = 1,500 X £130 X 1.015 = £197,925.00

YEAR 2

Opportunity Costs = 1,500 X £130 X 1.015 X 1.015 = £200,893.88

YEAR 3

Opportunity Costs = 1,500 X £130 X 1.015 X 1.015 X 1.02 = £204,911.75

YEAR 4

Opportunity Costs = 1,500 X £130 X 1.015 X 1.015 X 1.02 X 1.02 = £209,009.99

YEAR 5

Opportunity Costs = 1,500 X £130 X 1.015 X 1.015 X 1.02 X 1.03 = £215,280.29

Opportunity Costs Summary

YEARS

OPPORTUNITY COST

0

-

1

197,925.00

2

200,893.88

3

204,911.75

4

209,009.99

5

215,280.29

1.1.8 Net Present Value Calculation

In million

YEAR 0

YEAR 1

YEAR 2

YEAR 3

YEAR 4

YEAR 5

Land & Building

F

(5,000.00)

-

-

-

-

-

Plant & Equipment

F

(9,000.00)

-

-

-

-

-

Working Capital

F

(1,200.00)

(360.00)

(312.00)

(187.20)

(205.92)

2,265.12

Sales

F

-

5,495.20

13,179.76

17,205.98

20,498.87

22,285.67

Local Variable Costs

F

-

(2,730.00)

(6,552.00)

(8,648.64)

(10,306.30)

(11,336.93)

Fixed Costs

F

-

(156.00)

(187.20)

(205.92)

(226.51)

(249.16)

Total Before Tax

F

(15,200.00)

2,249.20

6,128.56

8,164.22

9,760.14

12,964.70

Taxation (20%)

F

-

(449.84)

(1,225.71)

(1,632.84)

(1,952.03)

(2,592.94)

Residual Value

F

-

-

-

-

-

964.29

Tax Relief

F

-

450.00

337.50

253.13

189.85

142.38

Total After Tax

F

(15,200.00)

2,249.36

5,240.35

6,784.51

7,997.96

11,478.43

Foreign Exchange (F - £)

256.00

327.88

387.64

418.04

450.83

481.47

Total in Pounds

£

(59.38)

6.86

13.52

16.23

17.74

23.84

Tax (10%)

£

-

(0.69)

(1.35)

(1.62)

(1.77)

(2.38)

Cash Flows (a)

£

(59.38)

6.17

12.17

14.61

15.97

21.46

Imported Components

£

-

0.08

0.15

0.19

0.21

0.22

Royalty

£

-

0.25

0.25

0.25

0.25

0.25

Opportunity Costs

£

-

(0.20)

(0.20)

(0.20)

(0.21)

(0.22)

Total

£

-

0.13

0.20

0.23

0.25

0.25

Taxation (30%)

£

-

(0.04)

(0.06)

(0.07)

(0.08)

(0.08)

Cash Flows (b)

£

-

0.09

0.14

0.16

0.18

0.18

Total Cash Flows (a + b)

£

(59.38)

6.26

12.31

14.77

16.15

21.64

Discount Factor (11.5%)

1.0000

0.8969

0.8044

0.7214

0.6470

0.5803

Net Present Value

£

(59.38)

5.61

9.90

10.66

10.45

12.56

Total Net Present Value (£ 'million)

(10.2)

1.1.9. THE ASSUMPTIONS MADE

The assumptions used in the NPV calculation above are:

Purchase Power Parity holds.

Exchange rates move in line with inflation.

Inflation rate is assume to be used as if the economic policies of the new government has been effective.

Current year is Year 0.

Fixed cost is at current year and expected to rise with current year's inflation level in Farland.

Fixed cost is expected to be charged in Year 1 onwards.

The exchange rate in year 0 for Dollar to Frollars is $1 : F143.82 (i.e. originated from $1.78 : F256).

Royalty will only be paid in Year 1 onwards.

All payments are due in the year it occurred.

All payments are assume to be paid in the same year in which it occurred.

Positive net cash flows derived from the project are considered as taxable profits.

The first claim for tax-allowable depreciation available can be used in year 1.

Any unused allowances can be carried forward.

Residual value of non-current assets need to be separated between (land and building) and (plant and equipment). Only plant and equipment portion is included in the NPV calculation.

It is assumed that the residual value amount is net of all taxes in Farland only.

Only positive net cash flows will be counted in the tax calculation as the tax authority will not make any tax refund for any losses made by the company.

1.2. REPORT FOR THE DIRECTORS OF TELTEC

Report Title: Investment evaluation for the assembly plant in Farland.

Author: Johnny Bravo Consultants

To: The Directors of Teltec PLC

Date: March 2013

Executive Summary

This report represent the analysis done with regard to the foreign direct investment opportunity in Farland. We have performed the net present value calculation of the project for the period of 5 years. The result shows that the project has a negative NPV. Our opinion is not to accept the project. Moreover, the project will expose Teltec PLC with various issues and risks such as the cultural issues, the opportunity costs and the foreign exchange rate risks exposure. The information received is not conducive enough. As for instance, the acceptance of the public towards the new government policies and the sequence of the election being conducted have not been provided. Therefore, we are at the opinion of not accepting the project as it has negative NPV and it will also involved many risks and uncertainties to Teltec PLC.

Introduction

The evaluation of the investment appraisal for the assembly plant in Farland started by calculating its net present value of the project for the period of 5 years. We will also analyse the deficiencies in the available information, identified useful information in decision making and other factors to consider before final decision is made. One of the reasons we use NPV method in the project appraisal is because it evaluates the project in the same way as the shareholders would evaluate it, i.e. by focusing on the impacts of a project to the shareholders' wealth.

Analysis

Farland is a less developed country which has recently elected a more stable government which encouraging foreign investment. Therefore, Teltec PLC is considering the establishment of an assembly plant in Farland. The planning horizon for the project is 5 years and at the end of the fifth year, a local company based in Farland would be willing to buy the business for 1,500 million Frollars for the non-current assets, net of all taxes, but excludes the working capital.

The NPV of the project of -£9.38 million indicates that the project will not increasing the shareholders' wealth. Therefore, the project should not be. Teltec PLC should only accept projects with positive NPV. Even so, there are many other aspects need to be taken into consideration before making any investment decisions. Further considerations will be provided below.

DEFICIENCIES IN THE INFORMATION RECEIVED

All available and applicable information have been incorporated in the NPV calculation. The information for the future amount were obtained based on the current market condition, management expectation and a high level of professional judgement. However, the figures given are not absolute. This is one of the identified deficiencies in the information received. Below are some other examples of the deficiencies.

First, the inflation rates used in the calculation are based on the assumption that the economic policies by the new government have been effective. The effectiveness of the policies are difficult to determine especially in an unstable country such as Farland. Hence, the figures are still not absolute and a high level of professional judgement is needed.

Second, the tax regulations used in the calculation are assumed to be the same as at the current year. There is a high possibility of changes for the tax regulations in Farland. It is because the new elected government being appointed and their encouragement for foreign direct investment might benefit Teltec PLC. Next, the discount factor of 11.5% has been calculated without taking the inflation rate into account. Hence, the figures are also not absolute.

Furthermore, the sales volume and the costs of production are based on expectation. There is no sign of the existence of competitors in the market being considered. Moreover, the buyer of the business at the end of the fifth year is merely a prediction. The supporting evidence of the potential buyer has not been obtained. Thus, both figures might not be accurate as well.

Consequently, there is a list of assumptions have been made based on the current situation, management expectation and a high level of professional judgement in deriving the figures. A list of assumptions used can be viewed at the end of the NPV calculation given.

USEFUL INFORMATION IN DECISION MAKING

However, there are useful information in decision making available. For instance, the new elected government could have a significant influence over the project is beneficial. The fact that they are currently encouraging foreign investment, they might open opportunities and give supports to Teltec PLC through the assembly plant project. They might impose leniency, shield or exemption in tax regulation of the company. Further negotiations with the government should be undertaken regularly especially during the planning and initial stage of the project.

Moreover, the fact that Farland is a less developed country which has been ravaged by war and unstable governments for a number of years. Teltec PLC has to consider the cultural issues when considering the establishment of an assembly plant in Farland. The cultural issues of different nationalities and even the issues within the organisation itself. Teltec PLC have to understand the cultural issues that might occur as it is very important for them in sustaining their reputation.

Last but not least, the fact that the investment in the assembly plant will reduce Teltec PLC existing exports from the UK by approximately 30% in perpetuity. This is a permanent loss towards the company specifically and towards the country in general. Although Teltec PLC have the ability to negotiate with the government of Farland, the project will only last for five years while the reduction of exports will not be recovered.

OTHER FACTORS TO CONSIDER BEFORE FINAL DECISION IS REACHED

Nonewithstanding, the external factors which are non-controllable by Teltec PLC should need to be considered as well. Since Teltec PLC is considering in expanding their operation in other country, it exposes them with variety of risks. The risk exposures are transaction, translation and economic risk exposures. Each risk has different effect towards Teltec PLC.

Transaction exposure is the risk that currency exchange rates will not be the same when the Teltec PLC enter into such obligation. The fluctuation in the exchange rates can lead to major losses to the company. Transaction exposure can be minimised through a hedging strategy. Hedging will allow Teltec PLC to convert the currency periodically, thus reducing the impact of the transaction exposures.

Next, translation exposure is the risk of the exchange rates associated with companies that deal in foreign currencies on their balance sheet. There is no physical cash flows in or out of the company affected. Hence, the most efficient way to minimise the impact of translation exposure is through hedging to match the assets and liabilities which relates to the foreign currencies.

Last but not least, economic exposure is the fluctuation of the exchange rates which will affect Teltec PLC's earnings, cash flows and foreign investment. It is more difficult to manage as compared to the other two exposures mentioned earlier due to its characteristic of long-term in nature. A good way to minimise the impact of economic exposure is through the derivatives which are offered over a long period with the possible exception of swaps.

Therefore, Teltec PLC need to ensure that they have sufficient resources to be able to minimise and control the risks being exposed to them. There is no available information on the Teltec's history which relates to any investment undertaken by them in other countries. For that reason, the ability of Teltec PLC in minimising and controlling the risks is questionable.

Conclusion

The foreign direct investment project in establishing an assembly plant in Farland should not be accepted. The reason are the project has a negative NPV and it will expose Teltec PLC with many risks and uncertainties. The negative NPV indicates that the project will not increase the shareholders' wealth. In addition, Teltec PLC need to consider the cultural issues in Farland. Moreover, the permanent loss of 30% in Teltec PLC 's existing exports should also need to be counted. Furthermore, expanding their operation to other country will expose Teltec PLC with new and unfamiliar risks to them. Therefore, Teltec PLC must make sure that they are fully prepared with sufficient resources in mitigating the exposure and control the impacts.

2. HOW THE POLITICAL RISK OF THE INVESTMENT IN FARLAND MIGHT BE ASSESSED

According to Accenture's 2011 Global Risk Management Study found that most organisations do not measure and manage the political risk. They tend to just accept the risk or avoid the opportunities exposed with high political risks. For example, in India, political risks vary from state to state. Some state have had publicised conflicts with the foreign companies but at the same time offer significant investment incentives. There are number of ways can be used to assess the political risk of the investment, in this case, in Farland.

Teltec PLC have a choice to form a risk management team (hereafter refers as 'risk managers') to identify and develop a set of risk determinants. The risk managers can use political risk expertise in Farland to assess and monitor the risks. They need to establish a broad political risk determinant and prioritise those risks that are most material to the company. The work need to be conducted in detail so that no information and scenario will be missing out.

Morales et. al. (2008) divided political risks into two which are micro-political risks and macro-political risks. Micro-political risks are the political actions that aimed only at specific foreign investments whilst macro-political risks are the political actions that aimed at a broad range of foreign investment. Some of the political risk determinants of foreign direct investment ('FDI') mentioned by them are stability and crime, infrastructure and informality, factor markets and government services. These determinants can be used in assessing the political risk of the investment in Farland.

Stability and Crime

Infrastructure and Informality

Factor Markets

Government Services

Economic and regulatory policy uncertainty

Telecommunications

Access to land

Tax rates

Macroeconomic instability

Electricity

Access to financing

Tax administration

Corruption

Transportation

Cost of financing

Customs and trade regulations

Crime theft and disorder

Anti-competitive or informal practices

Skills and education available workers

Labor regulations

Legal system/conflict resolution

Business licensing and operating permits

Sources from World Bank (2004), 'Investment Climate Survey 200-2003' cited in Morales et al. (2008).

First, the stability and crime determinant covers the economic and regulatory policy uncertainty. The macroeconomic instability can also be included as part of this determinant. In the case of Farland, the new government is welcoming foreign investment which might leads the rapid changes made in their economic and regulatory policies. Moreover, previous unstable government in Farland might allows corruption activities in dealing with them. The corruption activities might be normal in their business culture. However, it might not be the case as the new government appears to be more stable. Furthermore, Farland might have a high level of crime and theft rates as they have just been ravaged by war.

Second, infrastructure and informality determinant includes the telecommunication, electricity and transportation availability in the country. Farland is a less develop countries which might really need to improve these industries. Therefore, any investment made towards the improvements of these area will have the government interests. Since Teltec PLC is a manufacturer of telecommunication equipment, this might benefit them. However, Teltec PLC still need to conduct feasibility test for the project. All other factors need to be taken into consideration in accepting the project.

Next, factor market determinant refers to the ability to access the land, access to finance, cost of financing and the skills and education of available workers. Farland has a large supply of unskilled and semi-skill labour. Thus, Teltec PLC need to consider in posting their skilled labour in Farland if necessary. There will be a cultural issues arise. Teltec PLC also need to consider the financing methods available in Farland to be utilised especially for the hedging purposes.

Last but not least, government services determinant covers the tax rules and regulations, customs and trade regulations, labour regulations as well as business licensing and operating permits. Since the new government of Farland is currently encouraging foreign investment, it is a good news to Teltec PLC in considering the project. The tax rules and regulations in Farland will probably be amended to attract the foreign investors to invest in the countries. Therefore, it will increase the benefits gained by Teltec PLC. Nonetheless, Teltec PLC need to understand and comply with all laws and regulations implemented in Farland in order to sustain the business.

In summary, it is important for a company who wants to expand their operation in other country such as Teltec PLC to have the ability to identify, measure and manage political risks. In this case, Teltec PLC can gain a significant benefits from the investment project if they can assessed the political risks effectively and efficiently. A clear identification, measurement and management of the risks will allow Teltec PLC in improving their business performance and at the same time improve their growing strategies.

3. ADVANTAGES AND DISADVANTAGES TO TELTEC PLC OF SERVICING OVERSEAS MARKETS USING OTHER ALTERNATIVES

There are many ways or alternatives for Teltec PLC to penetrate the overseas markets such as through exporting, joint ventures and foreign direct investment. Each way has its own criteria and characteristics. This section will discuss the advantages and disadvantages of each and every alternatives mentioned.

3.1. EXPORTING

One alternative for Teltec PLC to expand their operation is through exporting, Exporting activities are the activities where the goods produced in one country are shipped to another country for future sales. There are many advantages and disadvantages related to the exporting activities.

One of the advantages is Teltec PLC can sell their excess production capacity available to overseas markets. It is very benefited to Teltec PLC if the excess in production has a very short useful life. It is better to sell it off as earlier as possible before the product becomes obsolete.

Other than that, Teltec PLC also will gain global market shares and at the same time gain new knowledge on how to improve their products and operation. Subsequently, Teltec PLC product will be known globally by its name, quality and reliability. Moreover, through exporting, Teltec PLC will also spreading the risk of unable to sell the product in their existing market.

Nonetheless, Teltec PLC will be exposed to other risks such as foreign exchange risk, financial risk, economic risk, etc. Teltec PLC should has the ability to identify and manage the risk and to conduct an impact assessment to make sure that the benefits should be more than the costs.

Most export activities required the exporter to have a license before operate. Therefore, Teltec PLC might need to apply and buy the license in the specific country in order to export their products to the country. This will eventually increase the costs to the company. Furthermore, Teltec PLC need the market information and to understand them. It is important to look at what the society wants and whether our products are suitable for them or not. Hence, this is another extra costs to the company.

3.2. JOINT VENTURES

Another alternative available for Teltec PLC in expanding their operational overseas is through joint ventures. Joint venture is a business arrangement made by two or more entities to pool their resources for the purpose of accomplishing a specific task. There are many advantages and disadvantages can be obtained by Teltec PLC through joint ventures.

One of the advantages is that Teltec PLC can increase the capacity of the production in order to meet the demand. Teltec PLC on its own might not have enough capacity to meet them. However, through joint ventures with other entities, Teltec PLC will have the access to greater resources and expertise in their operation. As a result, it will increase the productivity in terms of quantity and quality of the product.

Moreover, Teltec PLC can have the access and succeed in the new market, especially if Teltec PLC have a joint venture with local company who has a strong and reputable brand. In that case, there will be no excessive promotion and advertisement package needed. Even if it is a totally new market penetration for the entities in the joint venture arrangement, Teltec PLC will still have the advantages of sharing the risks associated with the other entities. Furthermore, Teltec PLC can utilise and learn new relevant knowledge from the joint venture entities and apply it in their operational activities.

On the other hand, Teltec PLC need to spend more time and effort to built a right relationship among the entities involved. It is particularly important to have a right relationship because the entities involved might betray Teltec PLC and become the rivals. It is also because each entity has different culture and management styles in their operation. It might delay the decision making processes and the cash flow projections. A considerable amount of times are needed for Teltec PLC to understand the potential entities involve in the arrangement in order to avoid any unnecessary costs in future.

Other disadvantage of joint venture is the imbalance in share capital and expertise may cause dispute between the entities. Subsequently, the objective of the ventures will not be clearly communicated to every entity. The lack of communication between the entities in the joint venture arrangement can make the situation worst and ultimately affect the business operation as a whole.

3.3. FOREIGN DIRECT INVESTMENT

Last but not least, another alternative available for Teltec PLC to expand their operational overseas is through foreign direct investment. Foreign direct investment is an investment made by an entity into another entity based in other country. The entity who made the investment has a significant influence and control over the other entity. It may be either by setting up a subsidiary or an associate company in the other country, by acquiring shares of the overseas company or through a merger or joint venture.

There are many advantages if Teltec PLC chose to use foreign direct investment in expanding their operation. One of the advantages is Teltec PLC can escape the barriers imposed by the government in penetrating the market in the country such as tariff wall. Some country might impose a very high tariff to promote their domestic products. Through FDI, Teltec PLC can promote their products without worrying about the tariff being imposed. In addition, Teltec PLC will have the access to a new labour market, new materials and resources available in the foreign countries.

Furthermore, Teltec PLC can secure their position in the market shares against their foreign competitors. Teltec PLC can implement cost leadership strategy to capture the market in the foreign countries they have invested in as the foreign companies might need to pay high tariff rate to be able to sell their products in the market. Moreover, it can improve the employment rate in the foreign countries due to the foreign direct investment undertaken by Teltec PLC.

Nevertheless, Teltec PLC should also consider the challenges in foreign direct investment. The different in language and culture in the foreign countries might be a big challenges. Furthermore, Teltec PLC might not be familiar with the foreign business tax laws and its regulations. An extensive research to gain the information and knowledge about the foreign countries is crucial to secure and succeed with their business operation in the foreign countries.

In addition, the situation where rapid changes of government in the foreign countries could lead to 'expropriation'. The 'expropriation' is a situation where the government take control of the entity's assets and property if they feel that the entity is a threat to the national security. Therefore, Teltec PLC need to be able to identify, measure and manage the political risks in the foreign countries before making any investment decisions.

QUESTION 2

1. FOREIGN DIRECT INVESTMENT AND CROSS-BORDER MERGERS/ACQUISITIONS: THEIR IMPACT ON THE RECENT WORLD WIDE ECONOMIC DOWNTURN ON THE PATTERN AND LEVEL OF SUCH INVESTMENTS

The aims of this literature review are to verify the impacts of different types of Foreign Direct Investment ('FDI') and cross-border merger and acquisition ('M&A') in economic downturn, the attractions for FDI and cross-border M&A and its determinants. FDI is an investment made by an entity into another entity based in other country. It may be either by setting up a subsidiary or an associate company in the other country, by acquiring shares of the overseas company or through a merger or joint venture. On the other hand, cross-border M&A is a corporate strategy dealing with buying, selling, dividing and combining of different companies belonging in different countries to help the entity grow rapidly without creating a new subsidiary.

The impact of FDI and cross-border M&A towards the economic downturn has been a hot debate among the researchers. In general, positive impacts of FDI can be derived from domestic saving gaps, technologies transferred, labour market upgraded and export increased (Leven B., 2012). The global recession crisis in 2008 has caused negative impact on FDI in many countries. However, Leven (2012) mention that FDI can stabilise the economic, and even increase it, after some structural adjustments being made.

Beugelsdijk, Smeets and Zwinkels (2008) state that different types of FDI affect the economic growth in different ways. Historically, many researchers conducted their research by combining all types of FDI together. Thus, it is not possible to determine the impacts of each type of FDI to the economic. However, recent researchers start to classify FDI into categories such as inward and outward FDIs, FDI-stock and FDI-flow and vertical and horizontal FDIs. For instance, a study conducted by Moon et. al. in 2011 found that both types of FDI, inward and outward, have the stabilizing effect on the country's economic during financial crisis. The positive impacts shown in the study were coming from the improvement in the production factors and methods, quality standards and the management skills prior to the financial crisis.

Moon et. al. (2011) also categorised FDI into FDI-stock and FDI flow in their study. They found that the prediction of FDI in stabilising the country's economic growth during the financial crisis is relevant, especially in the case of FDI-stock. On the other hand, the FDI-flow can speed up, but not stabilise, the uptake of the economic activities. Other than that, Beugelsdijk, Smeets and Zwinkels (2008) classify FDI into horizontal (market seeking) FDI and vertical (efficiency seeking) FDI in their study. They conclude that the growth effects of FDI would be more significant in horizontal FDI as compared to the vertical FDI. The study also test on the relationship between FDI and economic growth in developed and developing countries. They found that there is a significant relationship exist between FDI and the economic growth in developed countries but not in the developing countries.

Cross-border M&A activity is actually an entry mode of FDI. It can also be divided into inward and outward activities. According to Uddin and Boateng (2011), the main objective of the cross-border M&A is to gain the benefits from the new market that provides conducive economic environment, reduce the cost and enhance competitive advantage. The impacts of inward and outward cross-border M&As are very similar to the inward and outward FDIs discussed above.

These studies have proven that both FDI and cross-border M&A can give positive impacts in various ways to the economics of a country especially during the financial crisis. Therefore, many incentives such as export processing zones and tax incentives have been introduced by the policymakers to attract FDI as it is believed that FDI can brings positive impacts to the local economic development (Giroud, 2007). Moreover, Leven (2012) explains that the basis for FDI can be attractive in a recession situation are the stability of the currency, market openness, size, growth and its ability to trade, labour and productivity, subsidies and tax incentives offered by the policymakers.

Furthermore, Uddin and Boateng (2011) and Moon et. al. (2011) identify three broad variables which can attract FDI. First, the existence of ownership advantages of the entity's resources and capabilities. Second, the host country's location-specific advantages consist of tangible and intangible resources. And third, the organisational forms where the firms combine the first and second variables to maintain and improve their competitive positions.

What determine the level of FDI and cross-border M&A activities in associate with the economic growth? More general studies have been conducted to discuss on the determinants of FDI with regard to their association with the economic growth. For instance, a study conducted by Driffield and Love in 2007 investigate the knowledge spillover effects of different types of FDI. They found that both vertical and horizontal FDI generate positive knowledge spillovers, however vertical FDI is insignificant. Other possible determinants include the relevancy of the nationality (Buckley et al, 2007), technology and motives (Driffield and Love, 2007) and corporate structure (Javorcik, 2004).

In addition, Kok and Arsoy (2009) mention eleven determinants of FDI in developing countries in their study. They are gross FDI, electric power consumption, total external debt, technology gap, total debt service, inflation, domestic gross fixed capital formation, telephone mainlines, market size, trade and gross capital formation. Besides, Uddin and Boateng (2011) state the determinants for inward and outward M&A activities would be different from one another. The determinants level for inward cross-border M&A are the local currency, money supply, share prices and other economic factors. Whilst, the determinants level for outward cross-border M&A are the local currency, exchange rate, interest rate, share prices and other economic factors.

In conclusion, it has been proven by many researchers that the impacts of FDI and cross-border M&A are positive in the economic downturn, as what have been predicted by the policymakers. However, the level or the significant of the impacts are different for each types of FDI and cross-border M&A. Therefore, it is relevant for the policymakers to consider policies that can attract the FDI and cross-border M&A activities in the economic during its downturn. The determinants can be a benchmark for them to predict the level of such investment in the economic.