Question Details

United Kingdom, and expects the salvage (terminal) value of the project 


1. Effects of September 11. Arkansas Inc. exports to various less developed countries, and its
receivables are denominated in the foreign currencies of the importers. It considers reducing its
exchange rate risk by establishing small subsidiaries to produce products. By incurring some
expenses in the countries where it generates revenue, it reduces its exposure to exchange rate risk.
Since September 11, 2001, when terrorists attacked the U.S., it has questioned whether it should
restructure its operations. Its CEO believes that its cash flows may be less exposed to exchange
rate risk but more exposed to other types of risk as a result of restructuring. What is your opinion?

2. How Country Risk Affects NPV. Hoosier, Inc., is planning a project in the United Kingdom. It
would lease space for one year in a shopping mall to sell expensive clothes manufactured in the
U.S. The project would end in one year, when all earnings would be remitted to Hoosier, Inc.
Assume that no additional corporate taxes are incurred beyond those imposed by the British
government. Since Hoosier, Inc., would rent space, it would not have any long-term assets in the
United Kingdom, and expects the salvage (terminal) value of the project to be about zero.
Assume that the project- required rate of return is 18 percent. Also assume that the initial outlay
required by the parent to fill the store with clothes is $200,000. The pretax earnings are expected
to the £300,000 at the end of one year. The British pound is expected to be worth $1.60 at the end
of one year, when the after-tax earnings are converted to dollars and remitted to the United States.
The following forms of country risk must be considered:
• The British economy may weaken (probability = 30%), which would cause the expected
pretax earnings to be £200,000.
• The British corporate tax rate on income earned by U.S. firms may increase from 40 percent to
50 percent (probability = 20 percent).
These two forms of country risk are independent. Calculate the expected value of the project- net
present value (NPV) and determine the probability that the project will have a negative NPV.
284 International Financial Management



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