Question
Tovar Cie is a French firm that has been asked to provide
consulting services to help Gredia Company (in Country Y) improve
its performance. Tovar would need to spend 300,000 euros today on
expenses related to this project. In one year, Tovar will receive
payment from Gredia, which will be tied to Gredia’s performance
during the year. There is uncertainty about Gredia’s performance
and about Gredia’s tendency for corruption.
Tovar expects that it will receive 400,000Y if Gredia
achieves strong performance following the consulting job. However,
there are two forms of country risk that are a concern to Tovar.
There is an 80 percent chance that Gredia will achieve strong
performance. There is a 20 percent chance that Gredia will perform
poorly, and in this case, Tovar will receive a payment of only
200,000Y.
While there is a 90 percent chance that Gredia will not be
corrupt and make its payment to Tovar, there is a 10 percent chance
that Gredia will become corrupt, and in this case, Gredia will not
submit any payment to Tovar.
Assume that the outcome of Gredia’s performance is
independent of whether Gredia becomes corrupt. The prevailing spot
rate of country Y’s currency is 0.6 euros to the Y, but Tovar
expects that currency Y will depreciate by 10 percent in one year,
regardless of Gredia’s performance or whether it is corrupt.
Tovar’s cost of capital is 26 percent. Determine the expected
value of the project’s net present value. Determine the probability
that the project’s NPV will be negative
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