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?

Question

Quizplus · Accepted Answer

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 million

PV of cash inflows for the next 2 years: 
= $6 million / (1.16)^3 + $6 million / (1.16)^4 
= $9.98 million

PV of terminal value: 
= 0.5 ($2 million / (1.16)^5) + 0.5 ($8 million / (1.16)^5) 
= $3.16 million

Total PV of cash inflows: 
= $6.96 million + $9.98 million + $3.16 million 
= $20.1 million

Adjusted cash flows that can be repatriated: 
= 0.8 x $20.1 million 
= $16.08 million

Initial investment: 
= -$10 million

NPV = $16.08 million - $10 million 
= $6.08 million

Since the NPV is positive, it is profitable to invest in the foreign country. Therefore, option B is the best choice.

Chen Transport,a Canadian Company,is Considering Expanding Its Operations into a Foreign