Business

FinanceInternational Financial ManagementAccounting for Country Risk of a Project Kansas Co. wants to invest in a project in China. The proposed project would require an initial investment of 5 million yuan, but is expected to generate cash flows of 7 million yuan at the end of one year. The spot rate of the yuan is $0.12, and Kansas thinks this exchange rate is the best forecast of the future. However, there are two forms of country risk. First, there is a 30 percent chance that the Chinese government will require that the yuan cash flows earned by Kansas at the end of one year be reinvested in China for one year before they can be remitted (so that cash would not be remitted until two years from today). In this case, Kansas would earn 4 percent after taxes on a bank deposit in China during that second year. Second, there is a 40 percent chance that the Chinese government will impose a special remittance tax of 400,000 yuan at the time that Kansas Co. remits cash flows earned in China back to the United States. The two forms of country risk are independent. The required rate of return on this project is 26 percent. There is no salvage value. What is the expected value of the project’s net present value?FindFind*launch*

14th Edition

Madura

Publisher: Cengage

ISBN: 9780357130698

Chapter 16, Problem 24QA

Textbook Problem

Accounting for Country Risk of a Project Kansas Co. wants to invest in a project in China. The proposed project would require an initial investment of 5 million yuan, but is expected to generate cash flows of 7 million yuan at the end of one year. The spot rate of the yuan is $0.12, and Kansas thinks this exchange rate is the best forecast of the future. However, there are two forms of country risk.

First, there is a 30 percent chance that the Chinese government will require that the yuan cash flows earned by Kansas at the end of one year be reinvested in China for one year before they can be remitted (so that cash would not be remitted until two years from today). In this case, Kansas would earn 4 percent after taxes on a bank deposit in China during that second year.

Second, there is a 40 percent chance that the Chinese government will impose a special remittance tax of 400,000 yuan at the time that Kansas Co. remits cash flows earned in China back to the United States.

The two forms of country risk are independent. The required rate of return on this project is 26 percent. There is no salvage value. What is the expected value of the project’s net present value?

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