Question Details

Determine the NPV if Blustream uses this strategy 



Accounting for Uncertain Cash Flows. Blustream Inc. considers a project in which it will sell the
use of its technology to firms in Mexico. It already has received orders from Mexican firms that
will generate MXP3,000,000 in revenue at the end of the next year. However, it might also receive
a contract to provide this technology to the Mexican government. In this case, it will generate a
total of MXP5,000,000 at the end of the next year. It will not know whether it will receive the
government order until the end of the year.
Today- spot rate of the peso is $.14. The one-year forward rate is $.12. Blustream expects that the
spot rate of the peso will be $.13 one year from now. The only initial outlay will be $300,000 to
cover development expenses (regardless of whether the Mexican government purchases the
technology). It will pursue the project only if it can satisfy its required rate of return of 18 percent.
Ignore possible tax effects. It decides to hedge the maximum amount of revenue that it will receive
from the project.
a. Determine the NPV if Blustream receives the government contract.
b. If Blustream does not receive the contract, it will have hedged more than it needed to and will
offset the excess forward sales by purchasing pesos in the spot market at the time the forward
sale is executed. Determine the NPV of the project assuming that Blustream does not receive
the government contract.
c. Now consider an alternative strategy in which Blustream only hedges the minimum peso
revenue that it will receive. In this case, any revenue due to the government contract would
not be hedged. Determine the NPV based on this alternative strategy and assume that
Blustream receives the government contract.
d. If Blustream uses the alternative strategy of only hedging the minimum peso revenue that it
will receive, determine the NPV assuming that it does not receive the government contract.
e. If there is a 50 percent chance that Blustream will receive the government contract, would you
advise Blustream to hedge the maximum amount or the minimum amount of revenue that it
may receive? Explain.
f. Blustream recognizes that it is exposed to exchange rate risk whether it hedges the minimum
amount or the maximum amount of revenue it will receive. It considers a new strategy of
hedging the minimum amount it will receive with a forward contract and hedging the
additional revenue it might receive with a put option on Mexican pesos. The one-year put
option has an exercise price of $.125 and a premium of $.01. Determine the NPV if Blustream uses this strategy and receives the government contract. Also, determine the NPV if Blustream
uses this strategy and does not receive the government contract. Given that there is a 50
percent probability that Blustream will receive the government contract, would you use this
new strategy or the strategy that you selected in question (e)?



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