Suppose West farmers, an Australian multinational company, is considering launching a new project in Brazil.

The project is expected to generate cash flows of $1.5 million and $3 million for years 1 and 2, respectively, with an initial investment of $16 million. The firm projects perpetuity of $3.5 million in year 3 and beyond.

The firm expects that there will be an election in Brazil in year 4. Depending on the election results, with the probability of p, the firm will be expropriated, in which case the firm needs to withdraw their operation in Brazil with $3 million compensation.

On the other hand, if expropriation does not happen in year 4, the firm will continue to generate perpetuity of $3.5 million without further concerns of expropriation.

The required return on this investment is 8%.

 

Required: How large does the probability of expropriation in year 4 have to be before the investment has a negative NPV?

 

Use at least 4 decimal points in the middle steps and enter your answer up to 2 decimal points in the % term (e.g., 12.34%).

Answer rating: 100% (QA)

Heres how to calculate the probability of expropriation p that leads to a negative NPV for West farm... View the full answer