1.0 Introdu ction Australia Japan Cable (AJC) is a submarine cable network that links the east coast of Australi a 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 AustraliaGuam 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. $n the case of Australi athe branching cables oin some !! km offshore in water greater than +!!!m depth. 'he Australian landing points are located at 'amarama and ,arrabeenboth in -ydney. 'he cable stations associated with these landing points are at addington and /*ford 0alls respectively and the cable stations are linked to each other and to the beach manholes via land cables. /riginal sponsor groups are 'e lstraJapan 'e lecom'el eglobe and potential sponsor groups are A '1',''and 2C$ orldCom. AJC commenced operational service in 4ecember !!5. 'he cable configuration comprises two physically separate cable stations connected by fiber in each of AustraliaGuam 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 networ k provides access to high capacityhigh volumelow unit cost trans7acific and intra7Asia cables via Guam and Japan. AJC was upgraded with +!G t echnology in mid !5and with 5!!G technologies in late !53 and early !5+. $t is currently e6uipped to about 5!!!G bit#s A ustralia7Guam7Japan and has a potential capability to o ver &!!!Gbit#senabling 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 economicpoliticalfinancial condition. 4etermine 4iscount 8ate,9 $882$88 4etermine economicalenvironmentalpolitical risk and social situation 'o know how to take capital investment decisions 1
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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?<!
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
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
'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.
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
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>
-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)
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