Raymond Ltd. Textiles – Proposed solution
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Raymond Textiles – Globalization within Emerging Markets – Proposed solution
Case synopsis
Raymond Ltd. Textiles is a leading Indian manufacturer of textile products serving primarily its domestic
market. In January 2005, textile import quotas were eliminated under the Multi-Fiber Agreement
negotiated by the World Trade Organization. This effective liberalization of the global textiles market
represents both an opportunity and a threat for the company. At the moment, despite long tradition and
large domestic market Indian textile industry is not fully competitive worldwide primarily due to higher
labor costs, inflexible market regulations and lacking exporting infrastructure causing shipment delays in
Indian ports. Therefore, Raymond Textiles has decided to locate worsted-fabrics manufacturing plant
outside India. The company considers three countries: China, Malaysia and Thailand. Even though
China offers the largest demand market of all candidates the company has eventually decided to select
Thailand based on the most attractive investment incentives obtained, the highest cultural compatibility
with India and its desire to produce “non-Chinese” textiles so that customers can partially diversify their
current high supply dependence on China.
The new plant is worth 1,746 million Thai baht (around 40 million USD) its planned financing is a project
finance structure with 50% debt (non-recourse to equity sponsors) and 50% equity (provided by Raymond
Textiles as a sole sponsor). The new plant will employ Thai labor force and procure local utilities while
importing raw wool from Australia, polyester tow from India and plant technology from Europe. The
outputs are to be exported to Japan, Korea and USA and all output textile prices shall be quoted in US
dollars. Raymond has evaluated project profitability using internal rate of return (IRR) approach.
Project’s real IRR of 12.86% only slightly exceeds company’s domestic hurdle rate of 12%. In order to
present the project to the Executive Board Mr. Gupta and Mr. Bhagaria must finalize the project analysis
and prepare to defend their recommendations to the Board.
Case scope and teaching objectives
We believe that this case offers a very unique and rich background for analyzing project financing in
emerging markets. Not only the target investment country is an emerging market but also the investor
operates out of another emerging market. This case analyzes market forces in a rapidly changing textile
industry during its globalization phase. The new plant will be operating in a complex global textile value
chain using multiple currencies, both stable ‘hard’ currencies of developed countries and volatile ‘soft’
currencies of emerging markets.
The case can be used for illustrating a variety of interesting topics about project finance in emerging
markets. The situation provides rich background for following analyses:

Analysis of attractiveness of three different emerging markets (China, Malaysia,
Thailand) and selection of the best country for locating a dedicated investment

Analysis of sources of risks in an emerging market and risk mitigation measures resulting
from a tailored project finance structure

Calculation of industry-specific cost of equity for an asset located in a risky emerging
market and determination of adjustments resulting from risk mitigation measures in place

Cash flow based project valuation (WACC approach with changing debt-equity ratio)

Evaluation of valuation robustness using sensitivity analysis

Identification and analysis of real options embedded in the project
Raymond Ltd. Textiles – Proposed solution
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
Analysis of foreign currency exposure and optimal hedging strategy

‘What if’ analysis of project attractiveness under different circumstances
Even though we believe that it is useful to explore the full breadth of case analysis described above it is
also possible to focus on selected aspects of the case.
Selection of the most attractive country for investment
The case provides a detailed background about Raymond’s strategic objectives for locating its investment
and also a detailed information about the three countries considered. At this point students should focus
more on a qualitative analysis of political systems, economic conditions, business environments for
foreign investments, exchange rate mechanisms, availability of required resources as well as cultural fit.
For the case solution we would expect students to prepare a country selection table. In this table they
should identify the evaluation criteria, which they consider the most important, define their importance,
rank all three countries along these criteria and eventually determine which country is their preferred
location. Following figure offers an example of such an analysis.
Country Selection Criteria
China
Malaysia
Thailand
Business environment
Fiscal incentives
Flexibility of labor
Infrastructure facilities
Clarity in policies
Political risk
Currency risk
Economic stability
Domestic market-worsted
Best
Better
Good
In our solution we used the following rationale to rank the countries on each criterion:
Business environment – Thailand and Malaysia have a straightforward and relatively bureaucracy-free
business environment whereas China still carries a legacy from its communist past, which makes it more
complicated to run a business in China.
Fiscal incentives – The case gives details on the incentives offered by the Thai government.
Flexibility of labor – In this criterion there were no relevant differences among the countries, all have
very flexible labor legislation as a tool to attracting foreign investment.
Raymond Ltd. Textiles – Proposed solution
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Infrastructure facilities - In this criterion there were no relevant differences among the countries.
Clarity in policies – In this criterion again China presents its communist background and is in a relatively
worst position.
Currency risks – Although Malaysia also has a pegged currency to the US dollar, the size of the Chinese
economy and the impact it has in the world economy puts in check its ability to maintain its current
monetary policy.
Economic stability – In this case, the size of the Chinese economy and the impact it has in the world
economy makes it less vulnerable than the other countries.
Domestic market-worsted – China has a much larger market then the other two countries.
Considering the analysis above, we agreed with Raymond’s decision to select Thailand as the best
location for the new worsted-fabrics plant.
Cost of equity calculation for investment in Thailand
In order to determine the appropriate cost of equity for an investment into textile assets in Thailand we
recommend following approach (See Solution exhibit 1):
1. Calculate the required cost of equity for a similar investment in the US using CAPM
model with inputs for US risk-free rate, US market premium, US textile industry Beta for
unlevered assets and then calculate the US textile industry Beta for leverage
corresponding with Raymond Thailand Ltd.
2. Determine Thailand’s country risk premium over the US level based on the Institutional
Investor Country Credit Risk Rating (ICCRC) using Harvey’s cost of capital calculator or
another method (e.g. sovereign risk credit spreads adjusted for equity risk)
3. Analyze individual country risk categories: sovereign risk (direct and indirect currency
risk, asset expropriation, risk of wars and risk of natural disasters); operating risk
(resources and technology risks); financial risks (probability of default and existence of
political risk insurance) and determine which risks are mitigated by project’s unique
structure and which are not. (See the following chapter.)
4. Calculate adjusted cost of capital as US cost of equity + country risk premium for
Thailand – share of country risk mitigated by project’s unique structure
5. Convert US dollar denominated cost of equity (ad 4.) into Thai baht denominated cost of
equity by adding the inflation forecast differential
6. Convert the nominal Thai baht denominated cost of equity into real terms by subtracting
the forecasted Thai inflation
As you may note the fact that the investor originates from India does not need to be considered into our
analysis. The general principle is that from the finance standpoint project’s cash flows should have the
same value for all potential investors (from different home countries) otherwise an arbitrage opportunity
would exist. (This obviously disregards any strategic value to specific investor not represented by cash
flow projections.) We started from the US equity market because of data availability and also the fact the
Harvey’s cost of capital spreadsheet calculates the cost of equity in US dollars. We could have also
started from another equity market (e.g. India, Euro-zone) adjusting for the relative ICCRC rating
between that market and Thailand.
Sources of risk and risk mitigation measures of the project
Raymond Ltd. Textiles – Proposed solution
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We recommend discussing project risks into following categories: sovereign, operating, financial and
market risks. In addition, it is possible to split each into pre-completion and post-completion phases if
deemed necessary. It is essential for each risk sub-category identified to analyze how and to what extent
the risk is mitigated by the project structure (it can be also exacerbated) and finally to determine how the
risk will be evaluated, either through adjusting cash flows or through adjusting the discount rate. Both
approaches are possible, however the students shall avoid double-counting. We then suggest to assign
importance weights to those risks, which will be adjusted by the discount rate, and to increase / decrease
the country risk component of the cost of equity accordingly. Our proposed risk analysis follows. For
numerical calculation see Solution exhibit 2 (Harvey’s cost of capital calculator).
Risk category
Adjustment
approach:
Project’s mitigation measures
- In discount rate
- In cash flows
Degree of
mitigation (10=
fully, 0=at
country level, 10= much
greater
Assigned
weight
Sovereign risks
Direct currency
risk
(convertibility)
Discount rate
Reduced because 30% of cost
in hard currencies offset with
100% hard-currency revenues
+4
30%
Indirect currency
risk (political risk)
Discount rate
No mitigation
0
10%
Expropriation
(direct, diversion,
creeping)
Discount rate
Reduced as the Thai
government gave guarantee
against nationalization and
price controls
+5
15%
Commercial
international
partners
Discount rate
No long-term contracts with
international partners
0
4%
Involvement of
multilateral
agencies
Discount rate
No involvement
0
4%
Sensitivity of
project to wars and
strikes
Discount rate
Due to smaller importance
project’s sensitivity is lower
than average
3
5%
Sensitivity of
project to natural
disasters
Discount rate
Average sensitivity
0
5%
Resource risk
Discount rate
Project highly dependant on
non-diversifiable wool imports
from Australia
-5
5%
Technology risk
Discount rate
Use of a proven EU and Japan
technology
+8
8%
Operating risks
Raymond Ltd. Textiles – Proposed solution
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Financial risk
Probability of
default
Discount rate
With initial leverage of 50%
default probability is about
average
0
10%
Political risk
insurance
Discount rate
No insurance undertaken
0
4%
Prices of inputs
Cash flows
Input prices projected at
expected long-term values
Limited, no
long-term
contracts signed
Prices of outputs
Cash flows
Selling prices projected at
expected long-term values
Limited, no
long-term
contracts signed
Operating costs
Cash flows
Projected in real terms
Cash flows
Current exchange rates used
for year 1, consecutive years
projected using PPP exchange
rates
Market risks
Sovereign risk
Exchange rate
fluctuation
Partially hedged
Valuation approach: WACC versus IRR versus APV methods
At first it is necessary to notice that project finance structure is used for financing Raymond Thailand Ltd.
The subsidiary is set up as legally independent from Raymond Textiles and it takes on a non-recourse
debt from banks without a guarantee from the parent company. Under such circumstances project’s
capital structure matters because debt provides a ‘cheaper’ source of financing helping to resolve excess
free cash flow agency problems as well as increasing natural foreign currency hedge. We decided to use
WACC approach (weighted average cost of capital). As company’s capital structure changes while
Raymond Thailand Ltd. repays its debt over time, the WACC must be calculated for each period and cash
flows must be discounted period after period starting in year 13 and ending in year 1. See Solution
exhibit 1 for recalculation of cost of equity under different leverage ratios and Solution exhibit 3 for the
WACC calculation and overall valuation. The net present value is 355 million Thai baht (about $8.4
million relative to an equity investment of $20 million).
Alternatively an APV (adjusted present value) approach can be used. The IRR method used by the
investor is incorrect for two reasons: first it does not take into account the cost of project specific sources
of financing (different than if corporate financing was used) and second no adjustment is made to the
hurdle rate to account for Thailand’s country risks and project’s specific mitigation measures.
Valuation robustness: Sensitivity analysis
Even though the base case valuation results in positive NPV it is necessary to test valuation robustness
under different scenarios. Because we do not have information about expected price and exchange rate
fluctuations to run Monte Carlo simulation we decided to run at least sensitivity analysis providing breakeven values of inputs (project’s NPV = 0).
Raymond Ltd. Textiles – Proposed solution
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Solution exhibit 4 – Scenario 1: No government investment incentives shows that if Raymond
was not able to obtain the pre-negotiated investment incentives (8-year tax holidays and raw material
import tariff reduction from 30% to 1%) project’s value would be wiped out. Actually, project’s NPV
would be negative 314 million Thai bath and there would be no reason to undertake the investment
Solution exhibit 5 – Scenario 2: Decrease in selling price shows that if the average effective
selling price fell by 5.0% the project would break even (NPV = 0). 5% may seem to be relatively low
number but it must be realized that it is an average number throughout all 13 years of project lifetime, not
a price decrease just in a few years.
Solution exhibit 6 – Scenario 3: Increase in cost of foreign inputs shows that if the average
cost of imported foreign inputs, namely Australian raw wool and Indian polyester tow, increased by
14.4% throughout all 13 years the project would break even.
Solution exhibit 7 – Scenario 4: Exchange rate sensitivity shows that if Thai baht effectively
appreciated by 7.6% throughout all 13 years the project would break even.
It is worth noticing that the breakeven percentage changes of key inputs are relatively low (5%-14.4%).
Therefore with relatively small changes of assumptions the project’s NPV may become negative, which
underscores the importance of having precise estimates around the key operating variables. Even though
it is probably not practically possible to sign 13-year delivery and off-take contracts with suppliers and
customers the company should strive for longer term contractual agreements partially reducing input and
output price fluctuations.
Real options: Identification and analysis
The Raymond Thailand Ltd. project offers several benefits and future contingencies, which are not
considered in the Pro Forma projections prepared by the company. It would be incorrect to assume that
the reality will evolve over all 13 years as projected and that Raymond will have to do what it commits
itself to in the projections. In addition, the investment in Thailand plays a larger role within company’s
overall strategy and future growth. We will discuss these benefits and future flexibility as project’s real
options. Students should identify and analyze following real options:
Option to expand the project and extend its lifetime: Raymond Thailand Ltd. owns additional
20 acres of land in the investment zone, which are reserved for future capacity expansion. As this followon expansion will leverage some of this project’s fixed costs such as infrastructure development, local
authorities liaison, plant’s existing management overhead and other it will be less costly per unit of output
and thus the current project creates option value for future expansion. In addition, current projections
assume that the plant will be scrapped at the depreciated book value after year 13. It is reasonable to
assume that under favorable circumstances the company may decide to extend this lifetime. We believe
that the value of this option significantly contributes to our current valuation above.
Option to grow: As this investment is Raymond’s first step on its strategic path to grow fabrics
manufacturing in Thailand and other emerging markets its success will open up new possibilities of future
positive NPV investments. Therefore the Thailand investment can be viewed as a strategic move testing
feasibility of Raymond’s global growth strategy. By locating production outside India Raymond
overcomes current competitive disadvantages of Indian textile industry and realizes value through
benefiting from other country’s competitive advantages. Again, when the current project is successful
Raymond is likely to pursue similar new projects in the future. We believe that the value of this option is
also significant however it may be very difficult to quantify it given a vast variety of possible future
scenarios.
Operating scale and utilization option: Raymond Thailand has a flexibility to change
utilization of installed production lines depending on demand for different qualities of fabrics. This is a
Raymond Ltd. Textiles – Proposed solution
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standard real option of manufacturing investments, which allows for stopping production in case the
variable costs increase above product revenues. Given expected cost advantage of the Thailand’s plant
the value of this option is rather small as it is rather unlikely to come into money.
Output mix option and product flexibility: The installed machinery is to a great extent
dedicated to processing specific fiber diameter sizes and machinery cannot be converted to processing
different fabrics qualities. Therefore the possibility to modify product output is limited and stems
primarily from flexibility in the dyeing process. The value of this option is also rather small.
Shadow costs of another investment project: This project should not be considered on a
standalone basis as the decision of going ahead may preclude other investments. Raymond is unlikely to
pursue in parallel another worsted-fabrics production capacity investment and therefore Raymond
Thailand destroys any positive NPV of other similar projects. In addition, this project attracts a share of
management effort and attention during approval and pre-completion phases, which consumes this
valuable resource. This shadow cost option can actually have a negative value. One way to take care of
this option is to look at other alternatives (e.g. different location, different technology) and to make sure
that the Thailand investment has the highest NPV of all and thus lower shadow costs than other
alternatives.
We have used a more qualitative assessment of real option value. This may be satisfactory as the
project’s NPV is positive before these options and we can safely assume that the positive value of all four
options will actually outweigh potential shadow costs. Had the NPV been negative we would have to
calculate the option value to determine whether it outweighs the NPV or not. For such an analysis we
would suggest using one of two approaches: a) Binominal option pricing model which assumes
incorporating outcome probabilities directly to cash flows at each decision node or b) Monte Carlo
simulation which simulates model outcomes for varying input assumptions and presents outcome
distribution forecasts. However, the case presents only limited information for such an analysis and a
number of critical assumptions would have to be made.
Foreign currency exposure and proposed hedging
This case illustrates a situation involving a multiple of currencies. About 30% of input cost is incurred in
Australian dollars and India rupee, the remaining operating cost is incurred in Thai baht. Based on
current textile market pricing habits all selling prices will be negotiated in US dollars, even if exports are
destined for Japan, Korea or Pakistan. Currently the company considers using debt denominated in Thai
baht and US dollars. It is useful to analyze the currency risks the project bears as a result of these
complex foreign exchange cash flows. Solution exhibit 8 shows that effectively the project is long in US
dollars and even after subtracting Australian dollar input costs (assuming similar foreign exchange
fluctuations) and US$ debt servicing and repayment the dollar long position is covered only by about 3545% (see Solution exhibit 8 for the analysis). On the contrary, the project is short in Thai baht and other
emerging market currencies.
One may argue that this long position in ‘hard’ currency effectively resolves any foreign exchange risk as
Thai baht is more likely to depreciate than appreciate against US dollar. However, one should not simply
assume that past currency trends are likely to prevail to the future. Thai macroeconomic situation has
significantly improved since 1997 Asian crises and the inflation was brought down to levels of developed
countries, which makes the potential of appreciation more real. Therefore Raymond should consider
increasing the natural hedge of the cash flows even further. It is unrealistic to try to change the textile
market pricing habits and force customers to buy in Thai baht. The company should therefore try to
increase the share of US$ denominated debt (up to 100% of total debt) and also to extend its maturity to
maintain this borrowing hedge over longer period. In addition, for mid-term hedging the company can
use forward currency contracts (sell US$ for Thai baht).
Raymond Ltd. Textiles – Proposed solution
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How would Raymond’s decision change in 1997 after Asian crisis?
It is always useful to challenge our analysis and argumentation to considerably different circumstances,
which are still realistic. The interesting question in this case is how would Raymond Textiles analyze the
Thai investment opportunity shortly after the 1997 Asian currency crisis. The questions are:

How would the macroeconomic environment change after the crisis (high inflation,
currency devaluation, economic growth uncertainty)?

Would Raymond Textiles be able to secure third-party non-recourse debt from
international lenders shortly after they were forced to write off a large share of past
investments?

How would Thailand’s comparative advantages change (cost of labor, investment
incentives, etc.) as a result of the crisis?
It is interesting to notice that thanks to project’s long dollar position its profitability would actually
increase after Thai depreciation. As worsted-fabrics exports are primarily destined for developed
countries (Japan, Korea, USA) the economic recession in emerging markets would not significantly
impact value either. However, it is unclear whether borrowing could be tapped into shortly after the
crisis. The crisis would also negatively impact Thailand’s ICCRC credit rating and thus would increase
the required cost of capital and therefore would reduce project’s NPV. Rather than using the actual
Thailand’s ICCRC rating then we would have to make a longer-term projection incorporating
assumptions about future rating rebound.
Conclusion
In the end of the class the instructor should ask students whether they would or would not invest in the
project and whether they feel that they have enough information and have done sufficient analysis to be
able to present a recommendation to Raymond’s Executive Board.
Raymond Ltd. Textiles – Proposed solution
Sources:
The Economist Intelligence Unit
The World Bank
CountryWatch
Raymond Ltd. – Annual Reports, company web-site
DataMonitor – Global Textiles, Industry Profile, May 2004
ISI Emerging Markets, A Euromoney Institutional Investor Company
McKinsey Quarterly 2004 Special Edition – Freeing India’s Textile Industry
Solution exhibits: (See file:Raymond_solution_spreadsheets.xls)
1. Cost of equity calculation spreadsheet
2. Country risk analysis and mitigation measures
3. Valuation – base case
4. Valuation – Scenario 1: No government investment incentives
5. Valuation – Scenario 2: Decrease in selling price
6. Valuation – Scenario 3: Increase in cost of foreign inputs
7. Valuation – Scenario 4: Exchange rate sensitivity
8. Foreign currency exposure analysis
pg.9