Burton Co., based in the U.S., considers a project in which it has an initial outlay of $3 million and expects to receive 10 million Swiss francs (SF) in one year. The spot rate of the franc is $.80. Burton Co. decides to purchase put options on Swiss francs with an exercise price of $.78 and a premium of $.02 per unit to hedge its receivables. It has a required rate of return of 20 percent.
a. Determine the net present value of this project for Burton Co. based on the forecast that the Swiss franc will be valued at $.70 at the end of one year.
b. Assume the same information in part (a), but with the following adjustment. While Burton expected to receive 10 million Swiss francs, assume that there were unexpected weak economic conditions in Switzerland after Burton initiated the project. Consequently, Burton received only 6 million Swiss francs at the end of the year. Also assume that the spot rate of the franc at the end of the year was $.79. Determine the net present value of this project for Burton Co. if these conditions occur.