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 320 + 320 Gbit/s. It is a $520
million submarine telecommunication cable system. There are two landing points in each of Australia,
Guam and Japan and in each case cables from the landing points join at a branching unit in deep water
offshore and proceed as a single sheath to the next branching unit. In the case of Australia, the branching
cables join some 200 km offshore in water greater than 4,000m depth. The Australian landing points are
located at Tamarama and Narrabeen, both in Sydney. The cable stations associated with these landing
points are at Paddington and Oxford Falls respectively and the cable stations are linked to each other and to
the beach manholes via land cables. Original sponsor groups are Telstra, Japan Telecom, Teleglobe and
potential sponsor groups are AT&T, NTT, and MCI WorldCom. AJC commenced operational service in
December 2001.
The 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 required to
one of the two landings to a country. To enable onward connectivity the AJC network provides access to
high capacity, high volume, low unit cost trans-Pacific and intra-Asia cables via Guam and Japan. AJC was
upgraded with 40G technology in mid 2012 and with 100G technologies in late 2013 and early 2014. It is
currently equipped to about 1,000Gbit/s Australia-Guam-Japan and has a potential capability to over
5,000Gbit/s, enabling further upgrades as required.

1.1 Objective of the Case

The objective 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 project.
Identify the possibilities & problems of investment in Australia- Japan through required
factors like economic, political, financial condition.
Determine Discount Rate, NPV, IRR, MIRR
Determine economical, environmental, political risk and social situation
To know how to take capital investment decisions

2.0 Analysis of the Economy:

2.1 Economy analysis of Australia: The economy of Australia is one of the largest mixed market
economies in the world, with a GDP of US$1.525 trillion. Australia's total wealth is 6.4 trillion dollars. It
was the 12th largest national economy by nominal GDP and the 17th-largest measured by PPPadjusted GDP, about 1.7% of the world economy. Australia is the 19th-largest importer and 19th-largest
exporter. The Reserve Bank of Australia publishes forecasts of the economy quarterly.
The Australian economy is dominated by its service sector, comprising 68% of GDP. The mining sector
represents 7% of GDP; including services to mining, the total value of the Mining Industry in 2009-10 was
8.4% of GDP. Economic growth is largely dependent on the mining sector and agricultural sector (12% of
GDP) with the products to be exported mainly to the East Asian market.
Australia's average GDP growth rate for the period 19012000 was 3.4% annually. Growth peaked during
the 1920s, followed by the 1950s and the 1980s. By contrast, the late 1910s/early 1920s, the 1930s, the
1970s and early 1990s were marked by financial crises. From the early 1980s onwards, the Australian
economy has undergone a continuing economic liberalisation. In 1983, under Prime Minister Bob Hawke,
but mainly driven by Treasurer Paul Keating, the Australian dollar was floated and financial deregulation
was undertaken.

Annual percentage growth in real (chain volume) GDP per capita since 1960

The early 1990s recession came swiftly after the Black Monday of October 1987, resulting from a stock
collapse of unprecedented size caused the Dow Jones Industrial Average to fall by 22.6%. This collapse,
larger than the stock market crash of 1929, was handled effectively by the global economy, and the stock
market began to quickly recover. However, in North 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. The following recession thus impacted the many countries closely linked to the
United States, including Australia. Paul Keating, who was Prime Minister at the time, famously referred to
it as "the recession that Australia had to have."[35] During the recession, GDP fell by 1.7 per cent,
employment by 3.4 per cent and the unemployment rate rose to 10.8 per cent.[36] Despite this, there was a
beneficial reduction in inflation.

2.2 Economy analysis of Japan: The economy of Japan is the third largest in the world by nominal
GDP, the fourth largest by purchasing power parity and is the world's second largest developed
economy. According to the International Monetary Fund, the country's per capita GDP (PPP) was at
$36,899, the 22nd-highest. Japan is a member of G7. The Japanese economy is forecasted by the Quarterly
Tankan survey of business sentiment conducted by the Bank of Japan.
Due to a volatile currency exchange rate, Japan's GDP as measured in dollars fluctuates widely. Accounting
for these fluctuations through use of the Atlas method, Japan is estimated to have a GDP per capita of
around $38,490. In the three decades of economic development following 1960, Japan ignored defense
spending in favor of economic growth, thus allowing for a rapid economic growth referred to as
the Japanese post-war economic miracle. By the guidance of Ministry of Economy, Trade and Industry
with average growth rates of 10% in the 1960s, 5% in the 1970s, and 4% in the 1980s, Japan was able to
establish and maintain itself as the world's second largest economy from 1978 until 2010, when it was
supplanted by the People's Republic of China. By 1990, income per capita in Japan equaled or surpassed
that in most countries in the West.

GDP Per capita of Japan since 1960

However, in the second half of the 1980s, rising stock and real estate prices caused the economic bubble to
the Japanese economy by Bank of Japan. The economic bubble came to an abrupt end as the Tokyo Stock
Exchange crashed in 199092 and real estate prices peaked in 1991. Growth in Japan throughout the 1990s
at 1.5% was slower than growth in other major developed economies, giving rise to the term Lost Decade.
Nonetheless, GDP per capita growth from 2001-2010 has still managed to outpace Europe and the United
States

3.0 Analysis of Industry:

A market assessment tool designed to provide a business with an idea of the complexity of a particular
industry. Industry analysis involves reviewing the economic, political and market factors that influence the
way the industry develops. Major factors can include the power wielded by suppliers and buyers, the
condition of competitors, and the likelihood of new market entrants. That is why Australia Japan Cable its
very essential to do industry analysis before taking this project. Through the Porters five forces model we
will show the details of industry analysis.

3.1 Porters Five Forces Model

Porters Five Forces framework points out that the state of competition in any industry depends on five
competitive forces:
1) Threat of entrants,
2) Threat of substitutes,
3) Power of suppliers,
4) Power of buyers and
5) Rivalry among industrys firms.

However, a companys success in an industry depends on how it is related to that industry and how the
industry is structured. (Porter, 1980).
1.) Threat from new entrants:
A. Desire to gain market share
Porter indicates that new entrants bring with them new capacity and the desire to gain market share. New
entrants bring new capacity and the desire to gain market share. This desire puts pressure on costs, prices
and the rate of investment that is necessary to compete. Threat of entry depends on two factors: the height
5

of entry barriers and the incumbents reaction to new entrants.

According to Australia- Japan cable the

major entry barriers are:

Patents

Large capital requirements

Economies of scale

Governments regulations

Product differentiation

Predatory behavior by unions

Ownership of resources

B. High capital requirements:

Its quite normal that in cable industry a company needs huge investment. There is a huge capital
requirements positively affect communication sector because it limits the competition.
C. Time to learn for new competitors:
High learning curves positively affect profits for communication. When the learning curve is high, new
competitors must spend time and money studying the market before they can effectively compete.

2.) Rivalry among Existing Firms:

Major Cable companies are relatively equal in size, power and capabilities. This increases
the intensity of rivalry which can manifest itself in a price war if a competitor tries to
influence prices. But right now there is not much rivalry in AJC as all the companies in
association with World are working together as a new conglomerate.
3.) Threat from substitute products:
With the number of cable companies already in the industry, new entrants would find it
very difficult to make a strong showing in the market. Substitute has low impact in this
industry because of the many business opportunities that exist.
4.) Bargaining power of buyers:
Powerful buyers have the ability to reduce prices, demand better quality or more service
and play industry participants off against each other. AJC Company is in powerful position
6

to bargain prices, demand better quality or additional service. AJC companies seek to obtain
rights to invest in exploration and production areas internationally. These rights are
acquired through buying a percentage of another companys right or through participating in
licensing rounds.
5.) Bargaining power of the supplier:
Powerful suppliers affect the market through charging higher prices, limiting production and
by integration. There 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.
Technology &equipment are mainly supplied by the specific companies and by themselves.

3.2 PESTEL Analysis

PEST analysis stands for "Political, Economic, Social, and Technological analysis" and describes a
framework of macro-environmental factors used in the environmental scanning component of strategic
management. Some analysts added Legal and rearranged the mnemonic to slept inserting Environmental
factors expanded it to PESTEL or PESTLE, which is popular in the UK. Here we will use PESTEL
Analysis to describe macro-environmental factors of Australia.

Political
These factors determine the extent 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 project,
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 project.
Moreover, it will provide a huge cash flow in budget that can help them to take necessary steps on the
project that the government wants to implement.
Economic
This factor takes into consideration all events that affect the internal and external economic environment.
The internal or micro-economic events relate to the project viability and internal soundness of the
project .Australia communication systems are very good in terms of business applications. In comparison to
pager usage within the US, mobile phones (cell phones) have become very common and affordable among
teenagers, business people and families alike. In September of 2000 there were 51 licensed
telecommunication carriers operating within Australia. In June of 1999, there were around 850 service
providers, over 520 of these being Internet service providers (ISP's) throughout Australia. So not only is
cell phone usage, Internet access is also common throughout Australia. So the project of submarine cable
would be a profitable one. Improved broadband connectivity is also expected to increase the frequency and
quality of communications among the countries in the region, facilitating a growth in trade related services
such as tourism and back-office functions. A recent World Bank study indicates that a 10% increase in
broadband penetration results in a 1.38% increase in gross domestic product (GDP) growth in a country.
Social
The project will contribute to the socio-economic development of the region through the expansion of interAustralia and japan trade, facilitated by lower costs and better communication. The expected increase in
employment and income for the regions will help to reduce poverty and lead to sustainable development.
Additionally, the project will help in breaking the barriers of social and geographical isolation and assist the
population in its quest to access information and continued education.

Technological
These factors pertain to innovations in technology that may affect the operations of the industry and the
market favorably or unfavorably. This refers to automation, research and development and the amount of
technological awareness that a market possesses. As the telecom sector is highly evolving (in 1999), there
is always technology risk associated with such projects. There is a possibility of bigger and better
technology (which would handle higher and much bandwidth) in such an environment.
Environmental
These factors include all those that influence or are determined by the surrounding environment. Damage to
submarine cables can have a major impact on the Australian economy, protection of the security of
submarine cables is critical. Damage to subsea cables is mostly accidental, caused by fishing trawlers,
anchors, mining and dredging. However, there are growing fears internationally of the risk of sabotage to
cables. There are over 200 submarine cables buried in the ocean worldwide, connecting the global
telecommunications network and the global digital economy. Behind the abstract virtual cloud of
cyberspace is a very real physical infrastructure with some surprising vulnerabilities. Man-made causes
account for the overwhelming majority of damage caused to cables with 70 per cent of all cable faults
caused by fishing and anchoring in depths of less than 200 meters. Natural disasters, such as the earthquake
and tsunami in Japan, can also sever cables.
Legal
There 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
project, there is a chance that some legal problem may appear. For this reason the consortium signed
memoranda of understanding (MOU) with the two countries governments. In some countries, governments
only gave out permits for paths where cables and landing stations already existed, which meant dealing
with the owners of existing landing stations. After obtaining a permit and access to a landing station,
system owners had to get clearance from local fishing and government authorities. With a desire not to
disrupt fishing activities, authorities granted clearances for only short periods, often once or twice a year.

4.0 Analysis of the Company:

4.1 SWOT analysis
SWOT Analysis is a useful technique for understanding Strengths and Weaknesses, and for identifying both
the Opportunities open to us and the Threats we face. A business analysis of Australia Japan Cable,
submarine telecommunication cable system, focusing on the strengths, weaknesses, opportunities and
threats (SWOT) faced by the company.

Strengths
Telstra has a strong network of infrastructure, which supports its operations. The strong network
infrastructure backs the business operations and provides Telstra with a two-edge sorrow on
competition with other companies. In the retail business board, Telstra made a record about its
growing strongly. The operation had a better performance, due to the Telstra's strong retail broadband
performance. In the telecommunications market of Australian, Telstra is one of the most meaningful
companies. Telstra launch new services and improves its competition, which result from its strong
market position.
Weaknesses
Stockholders' faith and its brand worth are damaged for the weak relationship between the Telstra and
regulatory bodies.

10

Opportunities
In the telecom market of China, the operations business is expanded. In addition, the internet users of China
have reached 298 million up at a high of 42%. The internet penetration of China users is at 22.6% that is
very low, which has left a growth room. Chinese internet market can stimulate company's growth seeing
from its expanding at present.
Threats
In Australian, the mobile market has saturated. Telstra got amount of revenues from the Australian mobile
market, at the same time, operating performance of Telstra could be influenced in near term. However, in
the future years, the regulatory environment could have an impact on the Telstra's operation performance

4.2 Ratio analysis

Ratio analysis is a tool used by individuals to conduct a quantitative analysis of information in a company's
financial statements and the economy to judge the performance of the company. Here, we have analyzed
ratio of Australia Japan Cable projects original sponsor group (Telstra, Japan Telecom, and Teleglobe) to
evaluate various aspects of companys operating and financial performance such as its efficiency, liquidity,
profitability and solvency during the year 1998.

YEAR 1998
Current Ratio
Gross margin
Profit margin
Operating margin
ROA
ROE
Debt ratio
Fixed asset TO

Telstra
0.527803959
42.91%
17.36%
0.429103435
0.11348424
0.271114988
0.581416575
0.787809887

Japan Telecom
0.777065527
16.78%
1.96%
0.167789541
0.01437662
0.0305
0.528635399
0.988895939

Teleglobe
0.961997828
19.17%
-2.53%
0.191651969
-0.007279499
-0.010351468
0.296766548
0.338777136

11

4.2.1 Current Ratio:

The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term
obligations. To gauge this ability, the current ratio considers the total assets of a company (both liquid and
illiquid) relative to that companys total liabilities.

Interpretation: Current ratio of Telstra, Japan telecom and Teleglobe is under 1 which indicates their
liabilities are greater than their assets but Teleglobes financial health is good compared to Telstra and Japan
Telecom.

12

4.2.2 Gross Margin:

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

Interpretation: Huge gross margin indicates that Telstra has competitive edge over rivals that maintain
higher profit margins than Japan telecom and Teleglobe. Telstra retains more on each dollar of sales to
service its other costs and obligations.

4.2.3 Profit Margin:

13

Profit margins are expressed as a percentage and, in effect, measure how much out of every dollar of sales a
company actually keeps in earnings.

Interpretation: Net profit margin is mostly used to compare company's results over time. Net profit
margin measures how much of each dollar earned by the company is translated into profits. So here we can
say that, Telstra has proper chance to better over other than Japan telecom and Teleglobe.
4.2.4 Return on Asset:
An indicator of how profitable a company is relative to its total assets. ROA 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

14

Interpretation: Return on asset gives an idea as to how efficient management is at using its assets to
generate net income. Here Telstras ROA is much higher Japan Telecom and Teleglobe. Telstra is profitable
relative to its total asset compared to Japan Telecom and Teleglobe.

4.2.5 Return on Equity:

Return on equity measures a corporation's profitability by revealing how much profit a company generates
with the money shareholders have invested.

Interpretation: This ratio indicates how profitable a company is by comparing its net income to its average
shareholders' equity. Return on equity indicates the return on owners investment in this term Telstra data is
very positive and optimistic for company. From the above graph we can say that Telstras management is
more efficient in utilizing its equity base and better return is to investors than Japan Telecom and Teleglobe.

4.2.6 Debt ratio:

15

The debt ratio is defined as the ratio of total long-term and short-term debt to total assets, expressed as a
decimal or percentage. It can be interpreted as the proportion of a companys assets that are financed by
debt.

Interpretation: Debt ratio is the ratio of total liabilities of a business to its total assets. Debt ratio ranges
from 0.00 to 1.00. Lower value of debt ratio is favorable and a higher value indicates that higher portion of
companys assets is claimed by its creditors. So we can say that, Telstra and Japan telecom are more
leveraged company compared to Teleglobe.

4.2.7

Fixed Asset Turnover ratio:

16

The fixed asset turnover ratio compares net sales to net fixed assets. A high ratio indicates that a business is
doing an effective job of generating sales with a relatively small amount of fixed assets, outsourcing work
to avoid investing in fixed assets and selling off excess fixed asset capacity

Interpretation: The fixed-asset turnover ratio measures a company's ability to generate net sales from
fixed-asset investments - specifically property, plant and equipment (PP&E). Here Japan Telecoms fixed
asset turnover is higher than that of others which indicates the company has been more effective in using
the investment in fixed assets to generate revenues.

17

4.3 DuPont Analysis

DuPont analysis examines the return on equity analyzing profit margin, total asset turnover, and financial
leverage. We are using DuPont method for Australia Japan Cable project to know how much companys
assets generate sales or cash and how Telstra, Japan Telecom and Teleglobe will uses debt to produce
incremental returns.
Using these three factors, we could know efficiently and determine where the companies are weak or strong
of the business to look AJC project.

Particulars

Formula

Profit Margin

Net Income/
Sales

Equity Multiplier

Sales/ Total
Assets
Profit
Margin* TA
Turnover
Total Assets/
Common
Equity

ROE

ROA* Equity
Multiplier

TA Turnover
ROA

Particulars
Total Revenues (in millions)
Net Income/Loss (in millions)
Total Assets (in millions)
Total Shareholders' Equity (in
millions)

Telstra
0.17363374

Japan
Telecom
Teleglobe
0.019570099
-0.025279248

0.653584033

0.73462173

0.287963433

0.11348424

0.01437662

-0.007279499

2.1215

1.422002889

3.05%

-1.04%

2.389010031

27.11%

Telstra
10741
1865
16434
6879

Japan Telecom
3117
61
4243
2000

Teleglobe
1701
-43
5907
4154

Interpretation: From the above calculation we can find that Telstras ROE (27.11%) is higher than Japan
telecom and Teleglobe in 1998. This is why the total net income is higher than others. Both Equity
multiplier and profit margin of Telstra is higher than Japan telecom and Teleglobe. Total asset turnover of
Telstra is lower than Japan telecom but much higher than Teleglobe.
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4.4 Risk Analysis:

Risk analysis is a technique to identify and assess factors that may jeopardize the success of a project or
achieving a goal. This technique 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.
4.4.1 Country risk:
The country risk assessment has been made for both Australia and Japan by using the International Country
Risk Guide (ICRG) Methodology for Australia Japan Cable project evaluation. The International Country
Risk Guide (ICRG) rating comprises 22 variables in three subcategories of risk: political, financial, and
economic. A separate index is created for each of the subcategories. The Political Risk index is based on
100 points, Financial Risk on 50 points, and Economic Risk on 50 points. The total points from the three
indices are divided by two to produce the weights for inclusion in the composite country risk score. The
composite scores, ranging from zero to 100, are then broken into categories from Very Low Risk (80 to 100
points) to Very High Risk (zero to 49.9 points) and Low risk (70.0 to 79.9). All the variables & sub
components are ranked based on assumption as those data were unavailable at free of cost.

19

Country risk estimation of Australia and Japan:

The Political Risk Rating:
The risk that an investment's returns could suffer as a result of political changes or instability in a country.
Instability affecting investment returns could stem from a change in government, legislative bodies, other
foreign policy makers, or military control. In 1990s, under governments led for the most part by the longruling Liberal Democratic Party, Japan experienced a series of substantial changes in its political system,
changes that together add up to what may call a comprehensive overhaul.
In 1990s, Australia faced early recession. The Government of Australia promised economic recovery for
1991 and launched a series of asset sales to increase revenue. GDP sank, unemployment rose, revenue
collapsed and welfare payments surged. Till then the country is doing good.
Political Risk
Component
Composent
Govt Stability

Socioeconomic
Condition

Investment Profile

Internal Conflict

External Conflict

Corruption

Sub-sub component
Govt Unity
Legislative Strangth
Popular Support
Sub-Total
Unemployment
Consumer confidance
Poverty
Sub-total
Contract
Vaibility/Exproportion
Profit Repatriation
Payment delays
Sub-total
Civil War/Coup threat
Terrorism/ Political
Violence
Civil Disorder
Sub-total
War
Cross-Border conflict
Foreign Pressure
Sub-total

Hightest
Score
4
4
4
12

Score
(Austral Score
ia)
(Japan)
4
3
3
3
3
3
10
9

4
4
4
12

3
3
3.5
9.5

3
3
3
9

4
4
4
12
4

3
3
3
9
3.5

3
3
3
9
3

4
4
12
4
4
4
12
6

3.5
4
11
4
4
3
11
4

3.5
3.5
10
4
3
3
10
4
20

Military in politics
Religious tension
Law and order
Ethnic tension
Democratic
accoutibily
Bureaucracy Quality
Total=

6
6
6
6

3
5
4
5

3
5
5
2

6
4
100

4
3
78.5

5
3
74

Economic Risk:
This 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 countrys economic situation was not so good. Japans stock
exchange crashed in 1990 and Australia faced early recession in 1990s. However, right now both countrys
market is bit more stable and friendly.
(Australi
a)

(Japa
n)

The economic risk rating

Components
GDP per Head
Real GDP Growth
Annual Inflation Rate
Budget balance as a % of GDP
Current Account as a % of GDP

Points

Total=

5
10
10
10
15
50

4
8.5
9
8.5
8.5
38.5

Point
s
3.5
6.5
9
8
8.5
35.5

Financial Risk:
Financial 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. For Australia and Japan, now the
financial risk is improving we could see from the rating of financial risk. Exchange rate of currency is now
get more stability.

21

The Financial Risk

Components
Foreign debt as a % of GDP
Foreign debt service as % of Export of goods and
Service
Current Account as a % of Exports of goods and
services
Net international Liquidity as Months of Import cover
Exchange rate stability
Total=

(Austral
(Japa
ia)
n)
Points
10
7.5
7.5
10

7.5

15
5
10
50

13
4
9
42.5

12
4
8.5
39.5

The composite risk rating

Composite Political, Financial, and Economic Risk Rating,
CPFER(country)=0.5 (PR + FR + ER)
where,
PR = Total political risk indicators
FR = Total financial risk indicators
ER = Total economic risk indicators

So, CPFER (Australia)

= 0.5 (78.5+38+42.5)
= 79.75

This CPFER of Australia lies in the range of 70.0 to 79.9 points which defines Low Risk.

CPFER (Japan)

= 0.5 (74+35.5+39.9)
= 74.50

This CPFER of Japan also lies in the range of 70.0 to 79.9 points which defines Low Risk.

So from the country risk assessment we can say that both countries country risk is low and its a low risk
project to invest and possibility to get return on investment.

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5.0 Statement of the problem

The Australia Japan cable (AJ) project is a $520 million and 12,500-Kilometer submarine
telecommunication cable system. To build the system they need to choose equipment supplier, hire cable
ships and assess to landing station, right of way permits and harbor clearance.
The major problem with valuating the project lies as the following questions How market risk is major concern for fast changing telecom market?
How can mitigate risk if there is a project delay?
What discount rate should be used to evaluate a project that involves multiple countries?
What is the optimal capital structure for financing this project and how will the syndicate raise the
necessary debt?
What type of financing would be used to form AJC by Telstra? Why Telstra used such financing
strategy?
What problems Telstra and its sponsors had in mind while considering SCCN not the right
communication system between Australia, Japan, and the U.S.?
What kind of problems would arise if any of the sponsors want to exit the business? How the
problems would be handled?

6.0Alternative courses of action

Q1: What discount rate should be used to evaluate a project that involves multiple countries?
In this case, it is necessary to determine the cost of capital for the average AJC project. We assume the
premium for inflation as 9.12% according the economic trends and risk free rate is 5%. As we determined
the country risk we found Australia and Japan is a country of Low Risk for such type of project. So, we
may assign a low value of risk premium. Well consider it as 1%.
The discount rate=risk free rate+ inflation premium+ risk premium
Here, discount rate=5.00% + 9.12% + 1% = 15.12%
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Q2: How can mitigate risk if there is a project delay?

Preliminary estimate to build the system was $520 million but if there was a major completion delay
(environmental approvals and other permitting) system would be $567 million. So the cost of delay would
be $47 million. To mitigate completion delay they need to incorporate procedures that would allow AJC to
draw continues flow of funds.
Q3: What is the optimal capital structure for financing this project and how will the syndicate raise the
necessary debt?
For target capital structure, Telstra envisioned two debt tranchesTranche A: This secured and rapid (within 5 years) with presale commitments to purchase capacity.
Tranche A presales up to $337 million.
Tranche B: This repaid from future sales of capacity to other parties (within 5 years). Tranche B sales $145
million.
15 % equity and 85% of investment financed by bank lends guaranteed by presold capacity to sponsors and
other carriers.

Q4: How market risk is major concern for fast changing telecom market?
Market risk was major concern for AJC. To mitigate market risk they need Pre-sales capacity contracts
from highly rated companies covering approximately 2/3 rd of total project cost, Collapsed ring
configuration (lower cost) and Low cost capacity across North Pacific.
Q5: What type of financing would be used to form AJC by Telstra? Why Telstra used such
financing strategy?
Telstra wanted to use project finance as a way to conserve scarce capital as it wanted to limit the amount of
equity they had to invest in the project. For Telstra itself it wanted to hold around 40% of the equity 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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equity so that its partners would have meaningful equity positions and large enough shares to justify board
representation.

Q6: What problems Telstra and its sponsors had in mind while considering SCCN not the
right communication system between Australia, Japan, and the U.S.?
In mid-1997, the sponsors of the Southern Cross Cable Network (SCCN) were building a full
loop link between Australia and the U.S. Then Telstra and its sponsors suggested modifying
the project by removing the parallel path direct to the U.S.A., creating a link from Australia to
Japan, and acquiring capacity across the North Pacific. But the sponsors of the Southern
Cross project were not persuaded by their proposal.
Q7: What kind of problems would arise if any of the sponsors want to exit the business?
How the problems would be handled?
Resolving when and how sponsors could exit the business was clearly an issue to be
considered. As a private deal, sponsors will have liquidity concerns, which meant we needed a
process for valuing and selling shares. But having such a process in place worries bankers who
-make credit decisions based on the composition of the sponsor group. They agree to lend
because the purchase commitments come from high-rated sponsors and could get very
concerned if low-rated sponsor became owners.

7.0 Analysis of each alternative:

7.1 Valuation:
If the project is taken then we need to invest $520 million approximately. All system cost, construction
contingency and other development cost are included in the initial investment. We tried to minimize the
cost from estimated by making critical judgment. After establishing all facility to produce we can increase
sales by 5% yearly. We are hoping that variable cost will be 25% of sales. We have to maintain $25 million
working capital. We have used straight line method for depreciation. Because we dont know, which
method will be acceptable by Australia tax authority. We have taken all above factors under consideration
and then we calculated the NPV. The value of NPV comes $20 million. The project IRR is 15.75%. So, if
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the cost of capital is 15.75% then we will have neither profit nor loss. We will have profit in the project. For
re-assurance we ran 10000 trials in Monte-carlo Simulation. The Assumptions are given below:

Net Present Value:

The

simulation shows that the mean NPV is $25 million. It is clearly indication the profit of the project. The
risk of the project is low. So the simulation shows that the low riskiness of the project.
Simulation:
The NPV is negatively 27.7% sensitive to the Cost of Capital. If the cost of capital goes up the NPV
will go down. Also the NPV is negative to annual fixed cost and variable cost. The NPV is also 24.3%
positively sensitive to the sales growth rate.

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Internal Rate of Return:

After running 10000 simulations we find out the IRR is almost closer to previous IRR. The mean IRR is
15.69%, where previous IRR 15.75%. The riskiness of IRR is 9.99%. It is quite medium risky
investment to the context of IRR.

Sensitivity Analysis: The IRR is

positively 29.8% sensitive to the
Sales growth rate. If the sales goes
up the IRR will goes up by .298
for every 1% growth. The IRR is
also negatively sensitive to the
variable cost, annual fixed cost. If
variable cost and annual fixed cost
goes up the IRR will go down.

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Moderate Internal Rate of Return:

Its almost similar to the IRR. The MIRR is here 15.41%. In every case for 10000 times it will be 15.30%.
The mean vale is also 15.30%. The MIRR is 5.6% risky, which indicates low risk.
Sensitivity Analysis:
The MIRR is mostly sensitive to cost of capital sensitivity. MIRR is positively 30% sensitive to the cost of
capital rate. It indicates if cost of capital rate increased then the MIRR will go up. Also if sales growth rate
increased then the MIRR will goes up by 20.8%. If the variable cost goes up the MIRR will decrease by
27.5% and if the annual fixed cost goes up the MIRR will decrease by 21.7%.

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So, considering all the assumption we should take the project. Because all the assumption is showing that
Australia project is money earning project and the risk of the project is low except IRR, which will
contribute a fat amount to the income statement.

7.2 Real Option Consideration

The value of distinct project timing decisions becomes more apparent through a real options approach.
There is a possibility of upgrading the capacity (80 Gbit/s) after 5 years of operation. The managers of the
project can consider the possibility of upgrading the capacity (80 Gbit/s) as a real option. It is expected that
the benefits can be realized for 5 years. We had to value this real option and this value would be added to
the NPV of the project. If the value of the real option is negative then the managers will not exercise the
option. The amount of cost is $50 million. Net cash flow each year is estimated as followsProbability

Net cash flow

each year

0.1

12000000

0.2

18000000

0.35

23000000

0.25

30000000

0.1

40000000

The valuation of the real option is done by using the Black-Schole model. For that we had to assume some
elements, they are
Risk free rate (Rf) 5%
We assume cost of capital to be 15.12 %. (Using risk adjusted discount rate)

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Option pricing
PV of cash flows (S)
Investment (X)
Time (T)
Risk free rate (Rf)

69350312.24
50000000
4
0.05
0.427882826

d1
d2

1.043878154
0.188112502

N(d1)
N(d2)

0.851729117
0.57460577

35545309.47

Current Asset Value

Exercise (Strike) Price
Time to Maturity (Years)
Riskless Interest Rate (% p.a.)
Volatility (% p.a.)

The call option value is = $ 35545309

Since the real option price is positive, so it will increase the firms value. Hence, the option should be
taken.
Therefore, True NPV=Traditional NPV +real option value
=$20 million + $35.55 million
=$55.55 million; Therefore, we should take the project. That project will be
profitable for the company.
Here, with the basic Cash Flow Analysis we found the NPV positive ($20 million) and IRR 15.75% where
the cost of capital is 15.12%.
So, with exercising the real option the project can be accepted for investment.

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8.0 Recommendation:
During the feasible study of the project it was found out that there was a great demand of capacity in future.
Therefore the project should be taken in no time while there still is a little number of competitors.
Operational risks (delays due to suppliers, landing stations, etc) may be mitigated with the allocation of
contingency CAPEX (10% was used in this case). Governance risks can be mitigated by choosing sponsors
based on companys debt rating. The type of risks that prevail must be mitigated before starting the
construction of the AJC Company. Different scenarios have been anglicized during the calculation of free
cash flows and its element. Even In the worst case scenario, the project is still attractive meaning the
project got positive NPV. So without any doubt Australia Japan Cable project must be taken by the
investors. Source of risk of this kind of projects are: Market risks, operational risks, governance risks.
Market risks can be mitigated by selling capacity in advance and exploiting opportunities of deficit of
supply. As the real option value is positive, so it will increase the firms value and therefore AJC should
consider the real option.

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APPENDICES

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