Question Details

Determine the probability that the project- NPV will be negative 


1. The Risk and Cost of Potential Kidnapping. In 2004 following the war in Iraq, some MNCs
capitalized on opportunities to rebuild Iraq. However, in April 2004, some employees were
kidnapped by local militant groups. How should an MNC account for this potential risk when it
considers direct foreign investment (DFI) in any particular country? Should it avoid DFI in any
country in which such an event could occur? If so, how would it screen the countries to determine
which are acceptable? For whatever countries that it is willing to consider, should it adjust its
feasibility analysis to account for the possibility of kidnapping? Should it attach a cost to reflect
this possibility or increase the discount rate when estimating the net present value? Explain.


2. Integrating Country Risk and Capital Budgeting. Tovar Co. is a U.S. firm that has been asked
to provide consulting services to help Grecia Company (in Greece) improve its performance.
Tovar would need to spend $300,000 today on expenses related to this project. In one year, Tovar
will receive payment from Grecia, which will be tied to Grecia- performance during the year.
There is uncertainty about Grecia- performance and about Grecia- tendency for corruption.
Tovar expects that it will receive 400,000 euros if Grecia achieves strong performance following
the consulting job. However, there are two forms of country risk that are a concern to Tovar Co.
There is an 80 percent chance that Grecia will achieve strong performance. There is a 20 percent
chance that Grecia will perform poorly, and in this case, Tovar will receive a payment of only
200,000 euros.
While there is a 90 percent chance that Grecia will make its payment to Tovar, there is a 10
percent chance that Grecia will become corrupt, and in this case, Grecia will not submit any
payment to Tovar.
290 International Financial Management
Assume that the outcome of Grecia- performance is independent of whether Grecia becomes
corrupt. The prevailing spot rate of the euro is $1.30, but Tovar expects that the euro will
depreciate by 10 percent in one year, regardless of Grecia- performance or whether it is corrupt.
Tovar- cost of capital is 26 percent. Determine the expected value of the project- net present
value. Determine the probability that the project- NPV will be negative.



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