Trent Transport, a U.S. based company, is considering expanding its operations into a foreign country. 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 two years, and then a possible terminal value of $8 million. In addition, due to political risk factors, Trent believes that there is a 50 percent chance that the gross terminal value will be only $2 million and that there is a 50 percent chance that it will be $8 million. However, the government of the host country will block 20 percent of all cash flows. Thus, cash flows that can be repatriated are 80 percent of those projected. Trent's cost of capital is 15 percent, 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
E) $7.39 million

Question

Quizplus · Accepted Answer

The NPV is calculated by discounting the repatriated cash flows at the adjusted cost of capital (16%) and subtracting the initial investment. The expected terminal value is calculated as the average of the two possible outcomes ($2 million and $8 million), which is $5 million. The repatriated cash flows are 80% of the forecasted cash flows.