A business firm has a choice of two countries in which to undertake a project. The governments of Country 1 and Country 2 are honest and corrupt, respectively, in the sense that unlike Country 2, there is no diversion in Country 1. The startup costs of the two projects are $2 million and $2.1 million in Country 1 and Country 2, respectively. Neither project will yield any profits this year. The profits in Country 1 over the next two years equal $1.050 million and $1.764 million. The profits in Country 2 over the next two years equal $1.260 million and $1.9845 million. The interest rate equals 5 percent.
(a) Show that the firm is better off undertaking the project in Country 2 if there is no diversion there.
(b) For the firm to continue to undertake the project in Country 2, what is the maximum amount of diversion that Country 2 can force the firm to pay?