Question Details

Kansas thinks this exchange rate is the best forecast 


1. Capital Budgeting and Country Risk. Wyoming Co. is a non-profit educational institution that
wants to import educational software products from Hong Kong and sell them in the U.S. It wants
to assess the net present value of this project since any profits it earns will be used for its
Chapter 16: Country Risk Analysis 291
foundation. It expects to pay HK$5 million for the imports. Assume the existing exchange rate is
HK$1 =$.12. It would also incur selling expenses of $1 million to sell the products in the U.S. It
would be able to sell the products in the U.S. for $1.7 million. However, it is concerned about two
forms of country risk. First, there is a 60% chance that the Hong Kong dollar will be revalued to
be worth HK$1 = $.16 by the Hong Kong government. Second, there is a 70% chance that the
Hong Kong government imposes a special tax of 10% on the amount that U.S. importers must pay
for Hong Kong exports. These two forms of country risk are independent, meaning that the
probability that the Hong Kong dollar will be revalued is independent of the probability that the
Hong Kong government will impose a special tax. Wyoming- required rate of return on this
project is 22%. What is the expected value of the project- net present value? What is the
probability that the project- NPV will be negative?


2. Accounting for Country Risk of a Project. Kansas Co. wants to invest in a project in China, It
would require an initial investment of 5,000,000 yuan. It is expected to generate cash flows of
7,000,000 yuan at the end of one year. The spot rate of the yuan is $.12, and Kansas thinks this
exchange rate is the best forecast of the future. However, there are 2 forms of country risk.
First, there is a 30% 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 it can be
remitted (so that cash would not be remitted until 2 years from today). In this case, Kansas would
earn 4% after taxes on a bank deposit in China during that second year.
Second, there is a 40% 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 U.S.
The two forms of country risk are independent. The required rate of return on this project is 26%.
There is no salvage value. What is the expected value of the project- net present value?


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