AGOA: Who Benefits?

Running Head: AGOA: WHO BENEFITS?

AGOA: WHO BENEFITS?

Kolade Zackius-Shittu
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AGOA: Who Benefits? iii

Table of Contents

Table of Contents.....................................................................................................................2

EXECUTIVE SUMMARY...........................................................................................................1

INTRODUCTION....................................................................................................................2

Why AGOA?........................................................................................................................3

Capital Budgeting Process.........................................................................................................4

CAPITAL BUDGETING TECHNIQUES...........................................................................................5

Net Present Value (NPV)..........................................................................................................5

Internal Rate of Returns (IRR).....................................................................................................6

Modified Internal Rate of returns (MIRR).........................................................................................6

Discounted Payback (DPB)........................................................................................................7

Profitability Index (PI).............................................................................................................7

INDUSTRY PRACTICE.............................................................................................................8

CONCLUSION.......................................................................................................................9

REFERENCES......................................................................................................................10

Appendix 1..........................................................................................................................11
 AGOA: Who Benefits? 1

EXECUTIVE SUMMARY

The United States Government (USG) leverages its position as a world super-

power to promote free trade, provide access to capital and engender development through

various foreign policies. Other trade agencies such as office of the United State Trade

Representative (USTR), United State Trade and Development Agency (USTDA), United

State Export-Import Bank (EXIM), Overseas Private Investment Corporation (OPIC) and

so on work either as part or in collaboration with the US Department of State to promote

and implement US foreign and trade policies around the world.

The African Growth and Opportunity Act (AGOA) was signed into law in May

2000 by President W. Clinton as Title 1 of the Trade Development Act of 2000 to foster

collaboration between the USG and Government of African Countries to help the latter

develop free markets and open up their economies to growth through access to credit,

expertise and implementation of reforms crucial to the long term development of

participating countries. Participating Sub-Saharan countries are enlisted, delisted or re-

enlisted from the eligibility list from time to time based on their performance. Under

various political administrations, the USG have amended various parts of the legislation

to accommodate more products to be imported into the US with zero import duty.

This write up examines the AGOA legislation as a trade policy between the US

and Sub-Saharan African countries with a view to establishing the ultimate benefits of

this collaboration to both parties. This study will also attempt to establish any imbalance

that may exist or provide undue advantage to either party resulting from the

implementation of the AGOA trade agreement.

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Introduction, Why Agoa, Eligibility, Benefits, Different levels of Agoa,

impediments to AGOA implementation, AGOA and African Development, Are

African businesses losing out of the benefits? (A case study of textile funds in

Nigeria), Summary & Conclusion

INTRODUCTION

Regardless of its technological advancement, vastness of resources or ranking by

debt, like humans, no country can exist in practical isolation. Trade fosters rapid global

integration by helping to build the bridges that bring nations wide asunder to closer

proximity. Not only does trade bring countries closer, if properly used, it is also a weapon

in the fight against poverty. As a country, the US collaborates with countries and regional

blocs in its bid to forge closer economic tie and advance development. The North

America Free Trade Agreement (NAFTA) between the US and countries in North

America (Canada and Mexico) is an example. Often times, these relationships are tuned

and shaped on the learning that may occur over time.

Pre President W. Clinton passing of the AGOA legislation in May 2000, trade

relationships existed between the US and various African countries on an individual basis

based on different agreements. In addition, various US businesses either had thriving

businesses or were looking to take advantage of the market provided by Africa through
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Foreign Direct Investment (FDI) encouraged by economic reforms or other private sector

investment in different parts of the continent.

Although the AGOA legislation has gone through various phases of expansion

and elaboration since its initiation and signing, the over-riding objective still remains the

opening of both markets (US and Africa) to participation and greater opportunities for

mutual exploitation. These objectives open the doors for infrastructure development, job

creation and protection, and the building of a stronger diplomatic relationship and

alliance between the US and Africa. The decision of a country (or a region) to open its

border to trade is not isolated from the nature of its polity or its economic philosophy

(belief in capitalism, socialism, or any other hybrid). However, such a decision results

from what a country or the regional bloc stands to gain in the short and long time and

most often the opportunity cost associated with such a choice.

Why AGOA?

Amongst the many reasons one may advance in favor of AGOA, one of the findings by

the Congress leading to the enactment of this trade policy makes a very interesting point

and is worthy of mention. That is “certain countries in sub-Saharan Africa have increased

their economic growth rates, taken significant steps towards liberalizing their economies,

and made progress toward regional economic integration that can have positive benefits

for the region” (HR 434, 2000). leading to the may advance many reasonIn the final

analysis, firms embark on projects (ventures) that give the best value within a reasonable

time to recoup their investment, compensate for the risk, or provide additional streams of

income in a timely and economical fashion, supports organizational objectives, and so on.
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This is so because firms have competing needs for financial resources in the actualization

of firms’ strategic objectives which often times includes the maximization of

shareholders’ wealth. According to Parrino & Kidwell (2009), “Capital Budgeting

techniques help management systematically analyze potential business opportunities in

order to decide which are worth undertaking”.

It is important to mention that firms embark on capital expenditure spending for

reasons including but not limited to replacement of outdated equipment, expansion of

manufacturing plants, compliance with regulations, pursuance of various local and

international alliances, research and development of new products, and so on. Further,

Parino and Kidwell (2009) classifies potential capital budgeting projects into three broad

categories which are mainly independent, mutually exclusive and contingent projects.

Capital Budgeting Process

Rosenbaum & Pearl (2009) describes capital budgeting as capital expenditures

which are “funds that a company uses to purchase, improvement expand or replace

physical assets such as buildings, equipment, facilities, machinery, and other assets.”

Thus, decisions of this nature demand a carefully thought out process helps managers

make the best investment choices, that maximizes the firms’ wealth, compensates for

opportunity costs and aligns its results with organizational objectives.

The Peterson & Fabozzi (2002) five stages process for capital budgeting includes

investment screening and selection, capital budget proposal, budgeting approval and

authorization, project tracking, and post completion audit. Each of these processes

follows one another in a complementary manner like a process cycle. As the processes
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unfold, the performing organization learns and the managers are able to make the

necessary adjustments needed to keep the results in line with their expectations.

CAPITAL BUDGETING TECHNIQUES

This section will discuss capital budgeting techniques such as NPV, IRR, PI,

MIRR, and DPB, and highlights the advantages and shortcomings.

Net Present Value (NPV)

Firms finance projects using various techniques including the firm’s personal

funds, leveraged funds via joint venture partnerships, senior debts funds from banks (or

other financing agencies), and so on. For this reason, it is important for managers to

understand the NPV by comparing the proposed level of investment to the projected cash

flow for a given period taking cost of funds and opportunity cost into consideration.

Parrino & Kidwell (2009, p. 316) describe the NPV of a project as “the difference

between the present value of a project’s future cash flows and the present value of its

costs.” Ideally, firms consider projects with positive NPV while projects with negative

NPV may not gain any consideration. Because “NPV provides a direct dollar measure of

how much a capital project will increase the value of a firm” (Parrino & Kidwell, 2009),

pursuing projects with zero NPVs may seem an inefficient utilization of the firm’s

resources since they do not add any value to the firm. Positive NPVs signify a favorable

cash flow and while the reverse is the case for projects with negative NPVs.
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Internal Rate of Returns (IRR)

A firm can assess and compare the profitability of invested capital over a

particular period of time using the IRR method. IRR can be used an alternative to the

NPV because it also measures the time value of money, however, the IRR provides

information relating to the rate of returns required of an investment which can be

compared to the project’s opportunity cost to determine which investment has a higher or

lower returns, according to Parrino & Kidwell (2009). It is important to note that while

IRR is a discount rate that makes the present value of estimated cash flows equal to that

of initial investment (NPV = 0), this discount rate (IRR) does not take into consideration

other economic factors like inflation which may affect the eventual cash flow directly or

otherwise. In addition, neglecting real economic situations may lead to wrong project

decisions based on unrealistic expectation. Evaluating projects with IRR indicates which

projects maximize investor’s wealth as long as the projects are independent and are not

limited by capital rationing (Peterson & Fabozzi, 2002). However, it is important for

financial managers to re-evaluate using other tools like NPV or even look at the firm’s

historical performance if they feel the projected IRR is a suspect.

Modified Internal Rate of returns (MIRR)

Similar to the IRR, MIRR looks at the discount rate which equates the PV of cash

outflows for a given capital project with the PV of the terminal value of cash inflows

from the same project. This approach according to Parrino & Kidwell (2009) converts the

operating cash flows to a future cash value at the end of the project’s life compounded at

the cost of capital. Under the MIRR rule, projects are recommended for acceptance when
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the MIRR is greater than the cost of capital (Lefley, 1998), thus confirming the

attractiveness of such a project.

Discounted Payback (DPB)

The DPB answers rational investment question of how long it will take to

realize the capital invested in terms of its discounted cash flows. Somewhat similar to the

ordinary payback period, the DPB discount the future cash flows by the cost of capital

which according to Parrino & Kidwell (2009, p. 329), “tells management how long it

takes a project to reach an NPV of zero.” Nonetheless, DPB addresses the shortcoming of

the ordinary payback period by considering the time value of money.

Profitability Index (PI)

Having evaluated various assumptions and scenarios, it is may not be out of

place for a firm to attempt to understand the efficiency of their investment by comparing

the present value of the projected cash inflows with the initial investment (outflows).

Since PI is the ratio of the benefits of the investment (inflows) to the costs (outflows),

one may consider PI to be a comparison of benefits to costs. PI’s consideration for both

inflows and outflows, indicates that PI considers time value of money, wealth

maximization, riskiness of cash flows and its efficiency.

It is important to state here that these methods discussed above are based on

cash flows and may not be exhaustive. Organizations also consider other factors such as

market shares in a foreign market, joint venture for competitive advantage, research and

development for product development, and so on that may not portend immediate

financial gains. Appendix 1 presents a table that summarizes the strengths, weaknesses
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and ideal decisions firms may make based on the possible outcomes of the techniques,

within their limitations.

INDUSTRY PRACTICE

Various firms use a combination of tools such as the ones briefly discussed above

to aid capital budget decision, however industry practice seem to favor some tools over

others for various reasons. For instance, Peterson & Fabozzi (2002) alludes the popularity

of IRR to the fact that “it is a measure of yield and easy to understand”. Because of the

deficiency of IRR (including overly optimistic assumptions about reinvestment rate, see

Parrino & Kidwell, 2009), which may lead to selection of wrong project, Peterson &

Fabozzi (2002) further affirm that NPV may soon replace IRR as a popular method. In

comparison, Parrino & Kidwell (2009) reports that by 1999, 74.9% of firms surveyed

where frequently using the NPV compared to 16.5% in 1981. Similarly, 75.5% compared

to 65.3% where using IRR during the same period, confirming the earlier statement of

firms using a combination of tools. In support, Kierulff (2008) concludes that NPV and

IRR are the preferred measures of investment attractiveness; he however favors the

MIRR, affirming that the “MIRR is a more accurate measure of the attractiveness of an

investment alternative because attractiveness depends not only on the return on the

investment itself, but also on the return expected from cash flows it generates.” In the

light of all these, one may see the payback period as similar to a breakeven period, a

period when the cash outflows equals the inflow.

From a personal experience of offering advisory services to state governments

and institutions (in Nigeria) seeking to attract private investment in public infrastructure

development, investor are more interested in the preliminary cash flow projections and
 AGOA: Who Benefits? 9

the NPV. One also uses the cash flow projections to model dynamics of a project and

advice institutions and clients on equity participation, level and nature of debt sourcing,

the nature of incentives to propose to the prospective investors and so on. For instance,

since NPV information was essential in attracting high caliber investors in a concession

exercise involving water provision facility. The proposed annual payment for the

percentage of consumption by the government under the “take or pay” agreement had to

be increased to enable the investment to attain a positive NPV at a period less than the

concession tenure (25 years). Although developmental impact and social considerations

governed this capital budgeting decision on the part of that government, historical

information, and evaluation of profitability index showed that under the government, this

particular facility ran at a loss, hence the need to solicit private sector participation.

CONCLUSION

In order to actualize their strategic objectives, organizations make various

decisions including capital budgeting. Often times, firms have to consider and forecast

opportunity costs, costs of debts, risk exposures and other non-cash related outcomes

before embarking on a venture. In the best interest of the firm and its stakeholders,

projects with potential prospects that will add value by creating more wealth and

compensating for opportunity cost should receive favorable consideration. The various

techniques examined above are few of the ways firms may use to forecast cash flows. In

turn, these forecasts guide firms to make the best selection from the pool of projects

competing for the firm’s resources. Since a single technique may not tell the whole story,
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firms may base the final investment decision by using the outcome of a combination of a

number of techniques for consistency to support and justify such a decision.

REFERENCES

HR 434 (2000). Trade Development Act of 2000. Retrieved March 15, 2010, from

http://agoa.gov/agoa_legislation/agoatext.pdf
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Appendix 1.

Methodology Accept Reject Strength Weakness

NPV If NPV>0 NPV<0 or - Tells whether an investment - Requires a cost of capital for
will add value to a firm calculation
NPV = 0* - Consider all cash flows - Expressed in terms of dollars,
- Considers time value of not as a percentage
money
- Considers the riskiness of
future cash flows
IRR IRR> cost of IRR<cost of capital - Tells whether an investment - Requires a cost of capital for
capital increases firm’s value calculation.
- Considers time value of - May not give value maximizing
money decision when comparing
- Considers all cash flows mutually exclusive projects
- Considers riskiness of future - May not give value maximizing
cash flows decision when choosing
projects with capital rationing.
MIRR MIRR> Cost of MIRR< cost of - Tells whether an investment - May not give value maximizing
capital capital increases firm’s value decision when comparing
- Considers time value of mutually exclusive projects
money with different scales or risks
- Considers all cash flows - May not give value maximizing
- Considers riskiness of future decision when choosing
cash flows projects with capital rationing.
- Considers re-investment
DPB - Considers time value of - No concrete discussion criteria
money that tell us whether the
- Considers the riskiness of the investment increases the firm’s
cash flows involved in the value
cash flows - Calls for a cost of capital
- Ignores cash flows beyond the
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payback period
PI PI>1 PI<1 - Tells whether an investment - Requires a cost of capital for
increases firm’s value calculation
- Considers time value of - May not give correct decision
money when comparing mutually
- Considers all cash flows exclusive projects
- Considers riskiness of future
cash flows
- Useful in ranking and
selecting projects when capital
is rationed
Adapted from Peterson, P. & Fabozzi, F (2002). Capital Budgeting Theory and Practice. New York: Willey