How Country Risk Affects NPV
Response to the following problem:
Monk, Inc., is con- sidering a capital budgeting project in Tunisia. The project requires an initial outlay of 1 million Tuni- sian dinar; the dinar is currently valued at $.70. In the ?rst and second years of operation, the project will generate 700,000 dinar in each year. After 2 years, Monk will terminate the project, and the expected salvage value is 300,000 dinar. Monk has assigned a discount rate of 12 percent to this project. The following additional information is available:
• There is currently no withholding tax on remittances to the United States, but there is a 20 percent chance that the Tunisian government will impose a withholding tax of 10 percent beginning next year.
• There is a 50 percent chance that the Tunisian government will pay Monk 100,000 dinar after 2 years instead of the 300,000 dinar it expects.
• The value of the dinar is expected to remain unchanged over the next 2 years.
a. Determine the net present value (NPV ) of the project in each of the four possible scenarios.
b. Determine the joint probability of each scenario.
c. Compute the expected NPV of the project and make a recommendation to Monk regarding its feasibility.