Joint venture is another method to provide capital if a company doesn’t have enough equity to fund a project. Joint venture has some considerations to compare to debt and loan:
- In most cases, if a project fails, any bank loans and debt have to be repaid (depending on the loan agreement). But in a joint venture, the money doesn’t need to be repaid.
- Equity dilutes the ownership. In a joint venture, the profit will be shared between partners (based on their partnership), but the original investor can keep the entire profit, if she or he takes a loan instead of forming a joint venture.
- Debt and borrowed money may impose financial and non-financial restrictions on the investor (depending on the loan agreement).
- Depending on the performance of the project, the cost of equity may change over time, but cost of debt and loan are usually fixed.
- The interest portion of repaid money for the borrowed money and debt are deductible from tax, but the sum of money paid to the shareholders (dividend) is not.
Example 10-3
Following Example 10-1, assume a 50-50 joint venture that shares all the costs and benefits equally. Calculate the ROR and NPV at minimum rate of return 10%.
| Year | 0 | 1 | 2 | 3 | 4 |
|---|---|---|---|---|---|
| Revenue | 312,500 | 312,500 | 312,500 | 312,500 | |
| -Operating Cost | -110,000 | -110,000 | -110,000 | -110,000 | |
| -Depreciation | -166,650 | -222,250 | -74,050 | -37,050 | |
| -Working Capital Write-off | -50,000 | ||||
| Taxable income | 35,850 | -19,750 | 128,450 | 115,450 | |
| - Income tax 40% | -14,340 | 7,900 | -51,380 | -46,180 | |
| Net Income | 21,510 | -11,850 | 77,070 | 69,270 | |
| +Depreciation | 166,650 | 222,250 | 74,050 | 37,050 | |
| +Working Capital Write-off | 50,000 | ||||
| - Working Capital | -50,000 | ||||
| - Capital Cost | -500,000 | ||||
| ATCF | -550,000 | 188,160 | 210,400 | 151,120 | 156,320 |
So for this, After Tax Cash Flow
Please note that in this case (50-50 joint venture investment), ROR for each partner will be similar to the case that one investor provides the entire equity. However, NPV for each partner is half (partnership ratio); compared to one investor providing the entire equity case.