Johnson Controls
Emerging markets are riskier than established ones, and because of that Johnson Controls should make some adjustments to the method by which it evaluates capital investments when dealing in emerging markets. The 2013 Outlook and Strategic Review does not explain how risk is evaluated at Johnson, but the company would normally subject its capital investments to analysis that includes sensitivity analysis, and NPV with sensitivity analysis.
For emerging markets, the hurdle rate would be higher in order to account for the higher degree of risk. China represents over 50% of Johnson's business in Asia, so the company has a significant amount of knowledge about the risk conditions in the Chinese market. Thus, the company can set a hurdle rate that is appropriate to the Chinese market using available information. The company can also estimate the growth rate of China for the coming years, and the risk of inflation. Essentially, taking the same macroeconomic and market indicators that the company would use to analyze domestic risk, and applying it to the emerging market, is the most appropriate way to evaluate emerging market risk.
With better methods for evaluating risk that are more appropriate to emerging market conditions, risk will be reduced. The reason for this is that with better information, the company will be able to understand only projects that fit within its risk preferences. For example, with a higher hurdle rate to accurately reflect risk of any given project specifically, the company will not undertake some projects that it might otherwise have undertaken, had it used its ordinary domestic hurdle rate. By reducing the number of risky projects that the company takes in emerging markets, the company will reduce its overall risk as well.
In addition, the use of sensitivity analysis will help Johnson Controls to improve its decision-making, by providing better information about how changes to different key input variables will affect the overall evaluation of a given project. This technique should be used for all projects, but especially in emerging markets were volatility in some variables -- especially economic ones -- can be significant. By determining how robust a project is in the face of dramatic changes to key variables,...
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