How Country Risk Affects NPV Monk, Inc., is considering a capital budgeting project in Tunisia. The project requires an initial outlay of 1 million Tunisian dinars; the dinar is currently valued at $0.70. In the first and second years of operation, the project will generate 700,000 dinars in each year. After two years, Monk will terminate the project, and the expected salvage value is 300,000 dinars. Monk has assigned a discount rate of 12 percent to this project. The following additional information is available: There is currently no withholding tax on remittances to the United States, but there is a 20 percent chance that the Tunisian government will impose a withholding tax of 10 percent beginning next year. There is a 50 percent chance that the Tunisian government will pay Monk 100,000 dinar after two years instead of the 300,000 dinars it expects. The value of the dinar is expected to remain unchanged over the next two years. Determine the net present value of the project in each of the four possible scenarios. Determine the joint probability of each scenario. Compute the expected NPV of the project and make a recommendation to Monk regarding its feasibility.

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 16, Problem 19QA
Textbook Problem

How Country Risk Affects NPV Monk, Inc., is considering a capital budgeting project in Tunisia. The project requires an initial outlay of 1 million Tunisian dinars; the dinar is currently valued at $0.70. In the first and second years of operation, the project will generate 700,000 dinars in each year. After two years, Monk will terminate the project, and the expected salvage value is 300,000 dinars. Monk has assigned a discount rate of 12 percent to this project. The following additional information is available:

There is currently no withholding tax on remittances to the United States, but there is a 20 percent chance that the Tunisian government will impose a withholding tax of 10 percent beginning next year.

There is a 50 percent chance that the Tunisian government will pay Monk 100,000 dinar after two years instead of the 300,000 dinars it expects.

The value of the dinar is expected to remain unchanged over the next two years.

  1. Determine the net present value of the project in each of the four possible scenarios.
  2. Determine the joint probability of each scenario.
  3. Compute the expected NPV of the project and make a recommendation to Monk regarding its feasibility.

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