Question 1 International Capital Budgeting

Badwella United Company (BUC) is worried that its banana plantation in El Salvador will be expropriated during the next 2 years. However, BUC, through an agreement with El Salvadors central bank, knows that compensation of $100 million will be paid if the plantation is expropriated. If the expropriation does not occur, the plantation will be worth $400 million 2 years from now. A wealthy El Salvadoran has just offered $160 million for the plantation. BUC would have used a discount rate of 23% to discount the cash flows from its Honduran operations if the threat of expropriation were not present. Based on the price offered for the plantation to estimate the probability of expropriation. Hint: Set up a cash flow diagram and assume the probability of expropriation is constant.