Textbook Problem

Country Risk Analysis Recently, Best Bargain Co., a U.S.-based retailer, decided to consider expanding into various foreign countries; it applied a comprehensive country risk analysis before making its expansion decisions. Initial screenings of 30 foreign countries were based on political and economic factors that contribute to country risk. For the remaining 20 countries where country risk was considered to be tolerable, specific country risk characteristics of each country were considered. One of Best Bargain’s biggest targets is Mexico, where it plans to build and operate seven large stores.

1. Identify the political factors that might potentially affect the performance of the Best Bargain stores in Mexico.
2. Explain why the Best Bargain stores in Mexico and in other foreign markets are subject to financial risk (a subset of country risk).
3. Assume that Best Bargain anticipated that there was a 10 percent chance that the Mexican government would temporarily prevent conversion of peso profits into dollars because of political conditions. This event would prevent Best Bargain from remitting earnings generated in Mexico and could adversely affect the performance of these stores (from the U.S. perspective). Describe a way in which this type of political risk could be explicitly incorporated into a capital budgeting analysis when assessing the feasibility of these projects.
4. Assume that Best Bargain decides to use dollars to finance the expansion of stores in Mexico. Second, assume that Best Bargain decides to use one set of dollar cash flow estimates for any project that it assesses. Third, assume that the stores in Mexico are not subject to political risk. Do you think that the required rate of return on these projects would differ from the required rate of return on stores built in the United States at that same time? Explain.
5. Based on your answer to the previous question, does this mean that Best Bargain is more likely to accept proposals for any new stores in the United States than proposals for any new stores in Mexico?