Consider a foreign project in with the following expected free cash flows.

Year 0 1 2 3

E(FCF) -100 40 60 60

Required rate of return on the project: r_A = 13.5%, and the risk free rate of return r_F = 3.5%.

a. Determine the NPV of this project as modeled above.

b. Suppose the project faces a 10% chance of total expropriation (total loss of current and future cash flows) each year. Draw a diagram of the possible free cash flows outcomes of this project given this assumption for political risk. Label the free cash flows at each point and the probabilities for each path.

c. Determine the expected value of the FCF each period, (1 3).

d. Under the assumption that the risk of expropriation is not correlated with the market portfolio return, determine the expected NPV of the project given this political risk modeling.

e. Determine the best and worst NPV outcomes for the project from this modeling of political risk. Also indicate the probabilities of each of these extreme outcomes.

f. Suppose that an experienced investment banker said that rather than fool around modeling the cash flows, an easier way to incorporate the political risk is to just add a 9% premium to the projects cost of capital. Determine the NPV of the project under this political risk valuation assumption.