Pakistan Solar Energy Company - Case Study Example

Pakistan solar energy company Name; Institution affiliation; Date; Pakistan Solar Energy Company Introduction Solar Century is a UK company that has been dealing with manufacture and supply of solar energy panels including their installation not only in the UK but also internationally. For quite sometimes now, the company has been operating in Pakistan through agents. The few years’ experience has revealed to the company that Pakistan has a huge potential for marketing of its services in Pakistan. This is because Pakistan has sufficient solar energy potential in addition to the fact that the country has a large population yet to be connected to electricity. It is also the government policy to connect the population to power. In a bid to increase the company’s returns from this lucrative market, the company’s shareholders in December 2015 unanimously resolved to establish a Subsidiary in Pakistan under the name Pakistan Solar Energy Company (Rose-Ackerman, 2005). As a result, the board was tasked with the responsibility of conducting research in a bid to establish the advantages and the challenges that the company would be faced with in its decision to expand to Pakistan. Thus, this paper presents a report prepared for the Sola Century board of directors on the suitability of establishing the subsidiary in Pakistan. The report conducts both macro and micro economic analysis of Pakistan as well as the proposed subsidiary. It is hoped that the board will find the report useful as the company implements the decision to relocate to Pakistan. The Macroeconomic environment of Pakistan These are the conditions that exist in the whole economy as opposed to existing in a particular sector or industry of the economy. These include such factors as the trends in a country’s gross domestic product (GDP), employment and spending, inflation as well as fiscal and monetary policies adopted by a particular company. These factors are important to a company as they will determine whether or not it succeeds in a particular country as business and the economy don’t exist as an island and the actions of one affects the other. For instance, political instability will hinder business operations thus leading to losses or closure. In this regard, the report addresses a number of Pakistan’s macroeconomic factors including the GDP, inflation, business climate rating, the political as well as the social environment. it is worth noting that Pakistan has a high population of 186.3 million people and an unemployment rate of 5.2$ with foreign direct investment reaching $1.7 billion in 2016. Pakistani’s GDP trends In 2014, Pakistan attained a gross domestic product (GDP) worth 243.63 billion dollars which was equated to 0.39% of the entire global economy. This is tremendous growth from its $3.71 US billion dollars in the 1960. According to the World Bank country report on Pakistan, the country’s GDP grew by 4.2% in 2014 and is expected to grow by 4.5% in 2016. A growing GDP is important for a company like Pakistan Solar Energy Limited since it means growing consumption power and hence market for its products. Pakistan Taxation System On 13th September 2001, Pakistan promulgated its income tax ordinance of 2001 which defined its current Taxation system that became effective from 1st July 2002. Under the system, Pakistan’s corporate tax rate is 35% of a company’s net taxable income. It is worth noting that for a non-resident company, a 15% tax rate is levied on the gross amount of royalties or technical service fees with 30% being levied for other payments under the presumptive tax regime. Pakistan’s income tax rate for salaried working class is pegged on a graduated scale that ranges from 0.5% to 20% (Ottinger, 2013). For salaried male individuals, they are required to pay tax if and when their income exceeds PKR 200,000 while for female individuals; they are required to pay income tax when their income exceeds PKR 260,000. In addition, it is worth noting that the country has a 16% sales tax rate. It is worth noting that Pakistan’s tax rate regime is considered average given that there are many countries that charge higher taxes than the ones charged by Pakistan. Pakistan’s Fiscal and Monetary Policies Including Tax Rates A country’s monetary and fiscal rate adopted by the government is an important factor as they determine the availability of capital as well as the interest rates as well as the economy’s consumption potential. Pakistan has a fiscal policy with the main objective of sustained economic growth as well as decline in debts, alleviation of poverty, creation of job opportunities and investment in both human and physical infrastructure. It is worth noting that functioning of the financial markets; monetary stability and economic growth are related since monetary policy transmission indicates work through the channels of financial markets as well as bank based intermediation. Thus, Pakistan’s efficient financial system indicates strong economic growth thus providing investment opportunities. It should be noted that Pakistan’s benchmark interest rates were last recorded at six percent which is a bit low compared to many countries. The country’s interest rate has averaged between 11.78% percent between 1992 and 2015 though it reached an all-time high of 19.50 percent in October 1996 although its lowest was recorded in September 2015 at 6 percent. It is worth noting that the State Bank of Pakistan is charged with the responsibility of making interest rate decisions. Pakistan’s Inflation In February 2016, consumer prices in Pakistan rose 4.02% year on year prompted by a 3.32% growth in the previous month which was the highest level since December 2014. The increasing inflation resulted from increasing prices of food, housing clothing and footwear. From 1957 until 2016. Inflation in Pakistan has averaged 7.92% with its highest level being 37.81% in December 1973 and -10.32 as its lowest point in February 1959. However, it is worth noting that Pakistan regularly witnesses double digit inflation rate which may not be conducive for investment as it limits consumption owing to high prices of commodities. Pakistan Bureau of Statistics is charged with the responsibility of reporting on inflation. Pakistan’s Business environment The World Bank country report of 2015 terms Pakistan’s business environment as being very difficult. This is because corporate financial information is rarely available and when available, such information is usually much unreliable. The country’s legal system has been blamed for making debt collection very unpredictable with the institutional framework having very serious weaknesses. In addition, the report states that intercompany transactions can be very difficult to manage since the country has a highly risky business environment. As Pakistan Solar Energy Company sets base in Pakistan therefore, there is need to come up with strategies that will help it overcome such challenges. Pakistan’s political and legal environment Though there is a functioning government in Pakistan that is democratically elected, it is worth noting that the country has often experienced coups giving rise to dictators and the rule of the military. It is also worth noting that the country has in many times experienced acts of terrorism which act to make the country less attractive for investors. Before setting base in Pakistan therefore, the company should assure itself of safety against the above political factors (Chaudhry, 2009). As far as the rule of law is concerned, the country has been described as a repressed economy suffering from widespread corruption, lack of transparency and also lacking protection of property rights. There have been political and military interference with the Pakistan’s inefficient judiciary. The country has only made modest progress in improving its business environment with the cost of completing licensing requirements being over twice the average annual income. The country has a large portion of its workforce underemployed in the informal sector with the government and IMF agreeing that the government should move gradually to full cost recovery in the power sector, increase electricity rates and privatize distribution of power. Microeconomic factors Unlike macroeconomic factors, microeconomic factors are industry specific implying that the company has control over them and they in turn affect business performance. They include such factors as availability of capital, financial performance, and availability of raw materials as well as customers. This report analyses some microeconomic factors for Pakistan Solar Energy Company including the WACC, Capital structure and the solar energy sector in Pakistan. Brief overview of Pakistani’s solar energy industry It is worth knowing that Pakistan’s energy sector has traditionally been riddled by a variety of challenges which have ranged from increasing debt levels as well as over reliance on oil which is very expensive hence making the cost of energy in Pakistan to be very high. This is despite the fact that the country has immense potential for solar energy though this has not been fully exploited. It is worth noting that solar energy is available at a rate of 1000 watts per square meter in Pakistan. Thus, exploitation of solar power is seen as the only route that such remote and rural areas as the provinces of Sindh and Baluchistan can be powered. In Baluchistan for instance, 77 percent of the population live in rural areas where 90 percent of the population has not yet been connected to electricity mainly because this would be an expensive affair considering the fact that the villages are remote from each other to lay down transmission lines. Thus, solar energy presents a less costly solution. Pakistan’s government through its policy goals and development strategy supports a renewable energy policy regime evolvement as a way of systematically meeting its objectives of powering the entire Pakistan (Batra, 2003). In this regard, the government aims at first increasing the deployment of renewable energy technologies in a bid to provide a higher targeted proportion of the national energy supply mix with the government aiming at a minimum of 9700 MW by 2030 in accordance with its Medium Term Development Framework. This is also aimed at facilitating universal access to electricity in all Pakistan regions while providing additional power supplies to meet the ever increasing national demand. The government also aims at introducing investment friendly incentives while facilitating renewable energy markets for attracting private sector interest in renewable energy projects. This is aimed at helping nurture the nascent industry thus gradually lowering renewable energy costs and hence price through increased competition due to deregulation of the power sector. it is thus hoped that Pakistan Solar Energy Company will fully take advantage of this opportunity provided by a friendly government policy for the sector. In this respect, it is worth noting that Pakistan Electric Power Company Private Limited has been charged with the responsibility of restructuring and preparing for privatization of generation and distribution of electricity in Pakistan through the privatization commission. The privatization is aimed at promoting competition in the sector which would make private participants such as the proposed Pakistan Solar Energy Company Limited have a better operating environment. Weighted average cost of capital The company will use a variety of finance sources in establishing the Pakistan Solar Energy subsidiary. These will include company’s retained earnings and shareholders capital contribution. The company will also use bank debt as well as capital to be provided by an investor in Pakistan. The different source of finances will require different levels of returns with the company’s internal sources as well as the shareholders contribution requiring an annual return of 30.9% on capital. On the other hand, the debt from the Pakistani investor will require a return of 10% with the bank debt also requiring an annual return of 8.5%. The idea is to have the total capital being PKR 125,949,000 with PKR 31,636,000 funding coming from internal sources including shareholders contribution with the rest coming from external sources. As stated above, the corporate tax rate in Pakistan is 35%. Owing to the financing of the subsidiary coming from different sources, this has necessitated the calculation of the new company’s weighted average cost of capital. This is presented below; WACC for Pakistan Solar Energy Company Limited WACC = E/V*Re+D/V*Rd*(1-TC) Cost of Equity = 30.9% Cost of Debt =8.5*(1-35%) =5.5% Equity = 31,636,000 PKR Debt = 94,313,000 PKR WACC= (31,636,000/125,949,000*30.9%) + (94,313,000/125,949,000*5.5%)*1-0.35 = (0.0776+0.041)*0.65 =7.7% Where: E/V is the proportion of equity in the total capital Re is the required rate of return for equity D/V is the proportion of debt in the total capital Rd is the required return for debt. Projected Cashflow, Discounted Cashflow and Financial performance The appendix attached details out the projected financial performance of the subsidiary to be established in Pakistan. The financial statements include a projected income statement, projected balance sheet, a projected free cashflow statement and a discounted cashflow analysis. The discounted cashflow shows that each of the company’s ten million shares will be valued at PKR1.16. In addition, the projected financial statements show that the company is expected to operate profitable throughout the first five years of the company’s establishment. It should however be noted that for the company to achieve these results, a number of factors including aggressive marketing and a perfect supply chain has to be put in place to ensure quality of the company’s products. Capital structure As stated above, the company will have a combination of debt and equity in its capital structure. Equity will be composed of both the current members of the company as well as Pakistani members to be recruited. Already, Mohamed Noor a Pakistan leads the Pakistan shareholders with PKR 500,000 worth of shares. He shall serve of the chairman of the board of the subsidiary (Hazboun, 2015). Solar Century UK limited will be represented on the board by Mr. Brown White and Miss Christine Larry with the other two members being Pakistanis. It is to be noted that Mr. Abu Mohamed has agreed to lend PKR40, 000,000 to the company with the rest of the loan coming from Barclays Bank UK. It is to be noted that the board has agreed to grant Mr. Abu an opportunity to convert his debt into shares should he opt to. Competitive analysis There are many companies that offer solar energy solutions in Pakistan which is the same industry that Pakistan Solar Energy Company limited will operate in. such competitors’ include Socio engineering consultants, synercon, Trillium Pakistan Limited among others. Competitors may make it hard for the company to gain a sizeable market share in a short time and as such it is important that the company comes up with sound competitive strategies that will ensure it stays ahead of competition. Customers and suppliers As stated above, there is a very huge potential for solar energy in Pakistan which is a natural resource implying that there is adequate supply. On the other hand, the parent company in UK will ensure that all the necessary supplies are shipped to Pakistan on time. The company will also establish a supply chain in Pakistan for locally available materials. On the other hand, there exists adequate market for solar energy supply distribution in Pakistan as stated above. Conclusion This paper has presented a report to the board of management of solar century limited regarding the establishment of a Pakistan subsidiary. The report reveals great challenges that the company should expect to deal with by entering the Pakistan market. However, there are many opportunities provided by readily availability of solar energy as well as conducive government policies that favor establishment of the subsidiary. As such, it is important that the company comes up with strategies of dealing with the challenges so as to take advantage of the opportunity and hence expand its market in Pakistan thus improving its financial performance. References: Rose-Ackerman, T2005, Foreign direct investment and the business environment in developing countries: The impact of bilateral investment treaties, Yale Law and Economics, vol. 11, no. 3, pp. 12-35. Ottinger, R2013, Renewable energy law and development: Case study analysis, Northampton, Edward Edgar. Chaudhry, R2009, Renewable energy technologies in Pakistan: Prospects and challenges, Renewable and Sustainability, vol. 23, no. 2, pp. 12-19. Hazboun, E2015, Sustainable access to energy in the global south: Essential technologies and implementation approaches, New Jersey, Springer. Batra, K2003, Investment climate around the world: Voices of the firms from the world business environment survey, World Bank. Read More