Recently, J.C. Penney decided to consider expanding into various foreign countries; it applied a comprehensive country risk analysis before making its expansion decisions. Initial screenings of 30 foreign countries were based on political and economic factors that contribute to country risk. For the remaining 20 countries where country risk was considered to be tolerable, specific country risk characteristics of each country were considered. One of J.C. Penney’s biggest targets is Mexico, where it planned to build and operate seven large stores.
a. Identify the political factors that you think may possibly affect the performance of the J.C. Penney stores in Mexico.
b. Explain why the J.C. Penney stores in Mexico and in other foreign markets are subject to financial risk (a subset of country risk).
c. Assume that J.C. Penney anticipated that there was a 10 percent chance that the Mexican government would temporarily prevent conversion of peso profits into dollars because of political conditions. This event would prevent J.C. Penney from remitting earnings generated in Mexico and could adversely affect the performance of these stores (from the U.S. perspective). Offer a way in which this type of political risk could be explicitly incorporated into a capital budgeting analysis when assessing the feasibility of these projects.
d. Assume that J.C. Penney decides to use dollars to finance the expansion of stores in Mexico. Second, assume that J.C. Penney decides to use one set of dollar cash flow estimates for any project that it assesses. Third, assume that the stores in Mexico are not subject to political risk. Do you think that the required rate of return on these projects would differ from the required rate of return on stores built in the United States at that same time? Explain.
e. Based on your answer to the previous question, does this mean that proposals for any new stores in the United States have a higher probability of being accepted than proposals for any new stores in Mexico?