Country Risk and Project NPV
Solve the following problem:
Atro Co. (a U.S. firm) considers a foreign project in which it expects to receive 10 million euros at the end of 1 year. While it realizes that its receivables are uncertain, it decides to hedge receivables of 10 million euros with a forward contract today. As of today, the spot rate of the euro is $1.20, while the 1-year forward rate of the euro is presently $1.24, and the expected spot rate of the euro in 1 year is $1.19. The initial outlay of this project is $7 million. Atro has a required return of 18 percent.
a. Estimate the NPV of this project based on the expectation of 10 million euros in receivables.
b. Now estimate the NPV based on the possibility that country risk could cause a reduction in foreign business such that Atro Co. only receives 4 million euros instead of 10 million euros at the end of 1 year. Estimate the net present value of the project if this form of country risk occurs.