Political Risk and Project NPV Drysdale Co. (a U.S. firm) is considering a new project that would result in cash flows of 5 million Argentine pesos in one year under the most likely economic and political conditions. The spot rate of the Argentina peso in one year is expected to be $\$ 0.40$ based on these conditions. However, Drysdale also wants to account for the 10 percent probability of a political crisis in Argentina, which would change the expected cash flows to 4 million Argentine pesos in one year. In addition, it wants to account for the 20 percent probability that the exchange rate may be only $0.36 at the end of one year. These two forms of country risk are independent. Drysdale’s required rate of return is 25 percent, and its initial outlay for this project is $1.4 million. Show the distribution of possible outcomes for the project’s net present value.

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 27QA
Textbook Problem

Political Risk and Project NPV Drysdale Co. (a U.S. firm) is considering a new project that would result in cash flows of 5 million Argentine pesos in one year under the most likely economic and political conditions. The spot rate of the Argentina peso in one year is expected to be $\$ 0.40$ based on these conditions. However, Drysdale also wants to account for the 10 percent probability of a political crisis in Argentina, which would change the expected cash flows to 4 million Argentine pesos in one year. In addition, it wants to account for the 20 percent probability that the exchange rate may be only $0.36 at the end of one year.

These two forms of country risk are independent. Drysdale’s required rate of return is 25 percent, and its initial outlay for this project is $1.4 million. Show the distribution of possible outcomes for the project’s net present value.

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