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.
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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’sNPVwill be negative
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