Question

You are considering investing in a project in Mexico. The project will be a 2 year project, has an initial cost of 100K USD, and expected after tax profit of 1 million MXP per year. You expect the MXP to be valued at 0.12 USD/MXP. There are two major risks that you think have the potential to significantly affect project performance, which you assume are independent: * You think with probability of 0.22 that the MXP will depreciate to 0.1 USD/MXP. * You also think that with probability of 0.22 the Mexican economy will weaken substantially, in which case the project's after tax annual cash flow will be only 600K MXP. Your required return on the project is 18%. What is the expected value of the NPV of this project, as measured in USD?

Answer 1

It is stated in the question that both risks are independent, so it is considered seperately,

Calculations for considering thew depreciation in MXP,

The expected US$ / MXP as follows
	1	2	3=1X2
	USD/MXP	Probability	Expected $/MXP
	0.1	0.22	0.022
	0.12	0.78	0.0936
			0.1156
The NPV in Usdollars are as follows, We know that NPV = PV of cash inflow - Investment,
PV of cash inflow = PV factor X Annual cash flow, PV Factor = 1/(1+i)^n
n= corresponding number of the year (0, 1&2), i= required rate of return = 18% or 0.18

1	2	3	4 = (2X3)	5	6 = (4X5)
	Cash flow in MXP	$/MXP	Cash flow in $	Discount Factor @18%	PV in MXP
Year0			-100000	1	-100000.00000000000
Year1	1000000	0.1156	115600	0.8474576271186440	97966.10169491530
Year2	1000000	0.1156	115600	0.7181844297615630	83022.12008043670
				NPV	80988.22177535190

The Calculations for considering when Economy is weak
	The expected US$ / MXP as follows
		1	2	3=1X2
		Cash flow in MXP	Probability	Expected $/MXP
		600000	0.22	132000
		1000000	0.78	780000
		Expected cash inflow in MXP		912000
	The NPV in Usdollars are as follows, We know that NPV = PV of cash inflow - Investment,

1	2	3	4 = (2X3)	5	6 = (4X5)
	Cash flow in MXP	$/MXP	Cash flow in $	Discount Factor @18%	PV in MXP
Year0			-100000	1	-100000.00000000000
Year1	912000	0.12	109440	0.8474576271186440	92745.76271186440
Year2	1000000	0.12	120000	0.7181844297615630	86182.13157138750
				NPV	78927.89428325200

Please rate the answer maximum if you get the answer and satisfied. If you remains any doubts on this answer, please leave a comment and it will be cleared.

Thank you,…