Capital Budgeting and Country Risk
Solve the following problem:
Wyoming Co. is a nonprofit educational institution that wants to import educational software products from Hong Kong and sell them in the United States. It wants to assess the net present value of this project since any profits it earns will be used for its foundation. It expects to pay HK$5 million for the imports. Assume the existing exchange rate is HK$1 ¼ $.12. It would also incur selling expenses of $1 million to sell the products in the United States. It would be able to sell the products in the United States for $1.7 million. However, it is concerned about two forms of country risk. First, there is a 60 percent chance that the Hong Kong dollar will be revalued to be worth HK$1 ¼ $.16 by the Hong Kong government. Second, there is a 70 percent chance that the Hong Kong government will impose a special tax of 10 percent on the amount that U.S. importers must pay for Hong Kong exports. These two forms of country risk are independent, meaning that the probability that the Hong Kong dollar will be revalued is independent of the probability that the Hong Kong government will impose a special tax. Wyoming's required rate of return on this project is 22 percent.
What is the expected value of the project's net present value?
What is the probability that the project's NPV will be negative?