$26.$ Accounting for Uncertain Cash Flows. Blustream,

Inc., considers a project in which it will sell the use

of its technology to fi rms in Mexico. It already has

received orders from Mexican fi rms that will generate MXP$3$ million in revenue at the end of the

next year. However, it might also receive a contract

to provide this technology to the Mexican government. In this case, it will generate a total of MXP$5$

million at the end of the next year. It will not know

whether it will receive the government order until

the end of the year.

Today$$s spot rate of the peso is $$\mathrm{.}14.$ The oneyear forward rate is $$\mathrm{.}12.$ Blustream expects that

the spot rate of the peso will be $$\mathrm{.}13$ one year from

now. The only initial outlay will be $$300,000$ to

cover development expenses $($regardless of whether

the Mexican government purchases the technology$).$ Blustream will pursue the project only if it

can satisfy its required rate of return of $18$ percent.

Ignore possible tax effects. It decides to hedge the

maximum amount of revenue that it will receive

from the project.

a$.$ Determine the NPV if Blustream receives the

government contract.

b$.$ If Blustream does not receive the contract, it will

have hedged more than it needed to and will offset the excess forward sales by purchasing pesos in

the spot market at the time the forward sale is executed. Determine the NPV of the project assuming that Blustream does not receive the government

contract.

c$.$ Now consider an alternative strategy in which

Blustream only hedges the minimum peso revenue

that it will receive. In this case, any revenue due to

the government contract would not be hedged. Determine the NPV based on this alternative strategy

and assume that Blustream receives the government

contract.d$.$ If Blustream uses the alternative strategy of only

hedging the minimum peso revenue that it will receive, determine the NPV assuming that it does not

receive the government contract.

e$.$ If there is a $50$ percent chance that Blustream

will receive the government contract, would you

advise Blustream to hedge the maximum amount

or the minimum amount of revenue that it may receive? Explain.

f$.$ Blustream recognizes that it is exposed to exchange rate risk whether it hedges the minimum

amount or the maximum amount of revenue it will

receive. It considers a new strategy of hedging the

minimum amount it will receive with a forward

contract and hedging the additional revenue it

might receive with a put option on Mexican pesos.

The one$-$year put option has an exercise price of

$$\mathrm{.}125$ and a premium of $$\mathrm{.}01.$ Determine the NPV

if Blustream uses this strategy and receives the government contract. Also, determine the NPV if Blustream uses this strategy and does not receive the

government contract. Given that there is a $50$ percent probability that Blustream will receive the government contract, would you use this new strategy

or the strategy that you selected in question $($e$)?$