Cnooc, a Chinese public-sector company, has made a bid to purchase Unocal, a big

Question

Cnooc, a Chinese public-sector company, has made a bid to purchase Unocal, a big U.S oil company, for $18.5 billion in June 2005. Treat this as an initial investment made by Cnooc in this two-year, U.S based project. Frank F.X. Gong, chief economist for China at J.P Morgan has forecast that the Yuan will rise to 7.74 Yuan/$ by the end of 2005 and to 7.2 Yuan/$ by the end of 2006.

1. If it now purchased Unocal in August 2005, how many Yuan does Cnooc save on its initial investment because of the Chinese revaluation of the Yuan from 8.28 Yuan/$ to 8.11 Yuan/$ on July 21, 2005?

2. If the after-tax cashflows generated by the two-year, U.S based project are $12 billion at the end of 2005 and $14 billion at the end of 2006, and the chinese cost of capital is 15%, what is the NPV in Yuan?

3. Under what conditions would you recommend the APV technique to the Chinese company evaluating a U.S project?

Explanation / Answer

1. Savings = (8.28 Yuan/$ - 8.11 Yuan/$) * $18.5 billion

= 3.145 Yuan

2. NPV in Yuan = -18.5 billion * 8.11 + 12 billion * 7.74 / (1 + 15%) + 14 billion * 7.2 / (1 + 15%)2

= 6.95 billion Yuan

3. The APV method is especially effective when a leveraged buyout case is considered since the company is loaded with an extreme amount of debt, so the tax shield is substantial.

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