After the assessment of country risk analysis in Slovakia, Skymax Co., a U.S. firm, has considered to account for 30% probability of the political crisis. The Skymax Co is planning to invest $3.5 million in a project in Slovakia that will exist for one year. The required rate of return on this project is 28%. It expects to receive cash flows of 3 million euros in one year from this project. The spot rate of the euro in one year is expected to be $1.55, and the one-year forward rate of the euro is presently $1.45. Besides, Skymax Co. forecasted that the cash flows would drop to 2 million euros in one year if the crisis happens. However, Skymax Co. does not intend to hedge its expected cash flows.

a) Show the distribution of possible outcomes for the project’s estimated net present value (NPV), including the probability of each possible outcome.

(4 marks)

b) Now assume that Skymax Co. plans to hedge the cash flows that it believes it will receive if a crisis in Slovakia occurs. However, Skymax Co. decides not to hedge additional cash flows that it would receive if the crisis does not occur. Estimate what the net present value (NPV) of the project will be based on the hedging strategy described here, and assuming that a crisis in Slovakia does not occur.