International Financial Management 2nd Edition by Geert Bekaert ,Robert Hodrick

Exercise 1

Badwella United Company (BUC) is worried that its banana plantation in El Salvador will be expropriated during the next 2 years. However, BUC, through an agreement with El Salvador's central bank, knows that compensation of $100 million will be paid if the plantation is expropriated. If the expropriation does not occur, the plantation will be worth $400 million 2 years from now. A wealthy El Salvadoran has just offered $160 million for the plantation. BUC would have used a discount rate of 23% to discount the cash flows from its Honduran operations if the threat of expropriation were not present. Evaluate whether BUC should sell the plantation now for $160 million. (Hint: Set up a diagram.)