Chen Transport,a Canadian company,is considering expanding its operations into a foreign country for 5 years.The required investment at Time = 0 is $10 million.The firm forecasts total cash inflows of $4 million per year for 2 years,$6 million for the next 2 years,and then a possible terminal value of $8 million.Due to political risk factors,Chen believes that there is a 50% chance that the gross terminal value will be only $2 million and a 50% chance that it will be $8 million.In addition,the government of the host country will block 20% of all cash flows.Thus,cash flows that can be repatriated are 80% of those projected.Chen's cost of capital is 15%,but it adds one percentage point to all foreign projects to account for exchange rate risk.Under these conditions,what is the project's NPV?

A) $1.01 million
B) $2.77 million
C) $3.09 million
D) $5.96 million

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AshU??šH BH?daNi · Accepted Answer

Final Answer : B, Explanation :  To calculate the NPV, we need to discount all the cash flows back to time = 0 using the cost of capital adjusted for exchange rate risk.PV of cash inflows for the first 2 years:= $4 million / (1.16)^1 + $4 million / (1.16)^2= $6.96 millionPV of cash inflows for the next 2 years:= $6 million / (1.16)^3 + $6 million / (1.16)^4= $9.98 millionPV of terminal value:= 0.5 ($2 million / (1.16)^5) + 0.5 ($8 million / (1.16)^5)= $3.16 millionTotal PV of cash inflows:= $6.96 million + $9.98 million + $3.16 million= $20.1 millionAdjusted cash flows that can be repatriated:= 0.8 x $20.1 million= $16.08 millionInitial investment:= -$10 millionNPV = $16.08 million - $10 million= $6.08 millionSince the NPV is positive, it is profitable to invest in the foreign country. Therefore, option B is the best choice.

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