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Economy Assignment 2

The document discusses the economic principles relevant to investing in emerging markets characterized by high inflation and currency depreciation. It emphasizes a cautious, phased entry strategy prioritizing equity financing and local-currency debt to mitigate risks, while advocating for ethical considerations and stakeholder respect. The author reflects on the importance of prudence, stewardship, and integrity in decision-making processes amidst economic uncertainties.

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zaliaameera25
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1 views8 pages

Economy Assignment 2

The document discusses the economic principles relevant to investing in emerging markets characterized by high inflation and currency depreciation. It emphasizes a cautious, phased entry strategy prioritizing equity financing and local-currency debt to mitigate risks, while advocating for ethical considerations and stakeholder respect. The author reflects on the importance of prudence, stewardship, and integrity in decision-making processes amidst economic uncertainties.

Uploaded by

zaliaameera25
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FACULTY OF ENGINEERING

DEPARTMENT OF CHEMICAL ENGINEERING & ENERGY SUSTAINABILITY

KNC 3262 Engineering Economy

SEMESTER 2 - 2024/2025

Assignment 3

NO. NAME MATRIC NO.


1. ZALIA AMEERA BINTI ZAHARI 83003
Chapter 1 : Application of Economic Principles

When evaluating a potential investment in an emerging market characterized by annual inflation


rates ranging from 15 to 20 percent, significant currency depreciation, and fluctuating capital
markets, it is crucial to conduct a thorough analysis of the fundamental economic forces that shape
both risk and return dynamics. Sustained high inflation not only erodes the real value of future
cash flows but also necessitates that nominal revenues consistently exceed rising prices to maintain
purchasing power. If project returns fail to exceed the combined rate of inflation and an appropriate
risk premium, the net present value (NPV) may become negative when assessed in real terms,
signaling that the investment could ultimately destroy value (Gratton, 2024).

Furthermore, the unpredictable nature of input costs on spanning raw materials, labor, and other
operational expenses which intensifies forecasting uncertainty, compelling investors to adopt
higher discount rates. These rates are essential to account for the wider "state-price" dispersion
that can arise in such volatile environments. High inflation generally prompts central banks to
respond by increasing policy interest rates, which results in elevated costs of debt financing. While
fixed-rate borrowing might offer some protection against inflation in the long run by losing real
value, the immediate burden of higher coupon payments can strain early-stage cash flows and
profitability, potentially undermining the financial viability of the investment (Segal, 2024).

At the same time, any depreciation in the domestic currency significantly inflates the local-
currency cost associated with servicing foreign-currency debt. For example, a 25 percent
devaluation of the local currency would correspondingly inflate both interest and principal
payments on dollar-denominated obligations, thereby intensifying the financial strain on
businesses. Additionally, foreign exchange volatility can further destabilize expected returns, as
variations in repatriated earnings can lead to unpredictable cash flows and compel investors to seek
an additional currency risk premium to compensate for this added uncertainty.
Given these multifaceted challenges, equity financing emerges as a comparatively flexible option.
Unlike debt financing, which imposes immediate cash flow pressures through fixed obligations,
equity allows for the potential delay of dividend distributions when cash flows are constrained.
However, it's important to note that issuing equity during periods of depressed market valuations
can dilute the stakes of existing shareholders, potentially leading to resistance from current
investors. With these considerations, a prudent financing strategy in such an environment typically
involves a balanced combination of moderate local-currency debt and equity financing. This
approach aligns the liability of cash flows with local revenue streams, thereby mitigating the dual
risks associated with rising interest rates and currency depreciation, while also preserving the
flexibility to adapt to changing market conditions (Insurance Investor - Emerging Market
Currencies: The Role of Global Risk, 2019). Such a strategy not only helps safeguard against
immediate financial pressures but also positions the investment favorably for long-term growth
amidst the inherent volatility of emerging markets.
Chapter 2: Economic Decision Justification

Building on this comprehensive framework, I propose a nuanced, phased entry strategy that
emphasizes equity while incorporating built-in contingencies, as opposed to committing to an all-
in capital deployment from the outset. Our initial focus should be on allocating modest
expenditures—such as conducting thorough feasibility studies, launching small-scale pilot
operations, or acquiring minority equity stakes in reputable local partners. This approach allows
us to establish a strategic foothold in the market without exposing ourselves to the full spectrum
of macroeconomic risks inherent in more significant investments.

Concurrently, we should exercise caution by postponing large-scale capital expenditures until we


observe clear, reliable indicators of inflation moderation—specifically, inflation rates falling
below the 10 percent threshold—and stabilization of the foreign exchange market, defined as daily
exchange-rate fluctuations remaining below 1 percent (Insurance Investor - Emerging Market
Currencies: The Role of Global Risk, 2019). This careful observation ensures that we are making
informed decisions based on the evolving economic landscape. In structuring the eventual
financing, it is imperative to prioritize local-currency debt, which should be covenanted to the
project revenues, alongside equity investment. This strategy not only minimizes our reliance on
foreign debt but also mitigates the risks associated with currency mismatches, which can
undermine project profitability. Our hybrid “real-options” approach preserves the flexibility to
scale up operations when favorable conditions emerge, while simultaneously safeguarding against
potential downturns.

From an economic viewpoint, we should adopt a hurdle rate that adjusts from the conventional 12
percent real return to a more robust nominal range of 25–30 percent, aligning with the prevailing
inflation and interest-rate environment. If projections for project cash flows fail to convincingly
surpass this elevated threshold—even after implementing hedging strategies—delaying or
renegotiating the project becomes a prudent course of action (Shalal, 2025). Furthermore,
embedding macro-risk mitigants—such as foreign exchange hedges designed to protect projected
repatriations and comprehensive insurance against spikes in input prices—will significantly
bolster our returns and shield us from unforeseen challenges. On an ethical front, this cautious
strategy demonstrates a commitment to stakeholder respect. By avoiding the imposition of
overwhelming debt burdens, which could lead to layoffs or bankruptcies among local suppliers,
we uphold our responsibility to the community.

Additionally, by maintaining a zero-tolerance stance against corrupt practices through rigorous


due diligence, and by actively supporting community development through targeted investments
in workforce training and critical infrastructure, we reinforce our corporate integrity. By
harmonizing economic logic with a deep sense of stewardship towards our stakeholders, we aim
to capture sustainable, long-term upside while preventing the exacerbation of local instability and
preserving the integrity of our firm.
Chapter 3 :Personal Reflection

Throughout this complex decision-making process, I grounded my approach in the guiding values
of prudence, stewardship, and integrity, which helped me navigate the uncertainties and intricacies
we faced. Prudence prompted me to critically evaluate overly optimistic forecasts, fostering a
preference for optionality—recognizing that often the act of waiting can yield greater advantages
than committing to decisions amid significant volatility. Stewardship continually reminded me of
our fiduciary duty to protect both shareholder capital and the livelihoods of local communities;
this awareness informed my strategic decision to adopt a phased entry approach, prioritizing
gradual expansion over a hasty full-scale launch.

Driven by a commitment to integrity, I maintained an unwavering adherence to transparency and


ethical conduct, even when the prospect of accelerated deployment seemed enticing. To effectively
manage the stresses of decision-making and guard against emotional bias, I utilized a blend of
quantitative analysis conducting sensitivity analyses on variables such as inflation rates, exchange
rates, and discount factors which alongside qualitative insights derived from monitoring central
bank communications and geopolitical developments. I carefully structured these assessments into
a comprehensive scenario matrix, categorizing potential outcomes into best-case, base-case, and
stress scenarios, and established predefined trigger points to guide when to either escalate or
suspend our activities.

The anxiety surrounding potential adverse outcomes was alleviated through collaborative
discussions. Engaging with cross-functional teams—finance, legal, and sustainability—deepened
my understanding and reinforced the ethical dimensions of our decisions. My colleagues
frequently highlighted critical considerations, including potential labor impacts and environmental
risks, which sharpened my perspective and enriched our collective sense of responsibility. This
reflective practice ultimately underscored that robust economic modeling, while essential, is
insufficient in high-risk environments (Insurance Investor - Emerging Market Currencies: The
Role of Global Risk, 2019). The integration of ethical judgment and sincere empathy towards all
stakeholders is equally crucial. By consciously acknowledging my own biases and emotional
drivers, I was able to arrive at a balanced and responsible recommendation—one that aligns our
financial objectives with a broader commitment to sustainable and socially conscious investment.
References
Gratton, P. (2024, October 28). How Does Inflation Affect the Exchange Rate between Two
Nations? Investopedia. https://www.investopedia.com/ask/answers/022415/how-does-
inflation-affect-exchange-rate-between-two-nations.asp
Impact of higher inflation on cost of capital. (n.d.). https://www.roedl.com/insights/capital-
costs/inflation-expectations-capital-costs-company-valuation-growth-rate
Insurance Investor - Emerging market currencies: the role of global risk. (2019). Insurance
Investor. https://www.insuranceinvestor.com/articles/emerging-market-currencies-the-
role-of-global-risk/
Segal, T. (2024, April 12). What is inflation and how should it affect my investing? Investopedia.
https://www.investopedia.com/ask/answers/what-is-inflation-and-how-should-it-affect-
investing/
Shalal, A. (2025, April 25). World Bank chief economist sounds alarm on emerging market debt
issues, urges liberalization. Reuters. https://www.reuters.com/markets/world-bank-chief-
economist-sounds-alarm-emerging-market-debt-issues-urges-2025-04-25/

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