China is a manufacturing superpower. Assume that you are CFO of an automobile manufacturer looking to build a $4.2 (U.S.) billion plant in China. You are discussing this project with your spouse, who is intelligent, but has no background in finance.
1. Your discussion should begin with a clear and logical step-by-step explanation of the theory behind the concept of "required return" on proposed capital investments. Explain how cost of equity, cost of debt, WACC, and allowances for various risk factors are involved in determining the "required return" on proposed international capital investments.
2. Discuss each of the main risk factors that should be allowed for in addition to WACC in order to determine the appropriate required return on this capital investment opportunity.
3. Make a reasonable estimate of the required return, starting with a 8% weighted average cost of capital for the U.S. auto manufacturer, and adding realistic estimated percentages for each of the separate risk elements you can foresee. Explain how you arrived at the particular risk adjustment factor. (Keep in mind that China is not the "forbidden" country. Many US companies successfully manufacture their products in China. The Chinese are adept at doing business with Americans, and are able to deal with cultural differences. But building trust requires time.