The government of Zwill presently encourages investment in the country. Comstock International Mining Corporation, a US company, is planning to open a new copper mine in Zwill. The front-end investment is expected to be $25 million, after which cash flows are expected to be more than sufficient to cover further capital needs. Preliminary exploration findings suggest that the project is likely to be very profitable, providing an expected internal rate of return of 34 percent, based on business considerations alone.
The government of Zwill, like that of many countries, is unstable. The management of Comstock, trying to assess this instability and its consequences, forecasts a 10 percent probability that the government will be overthrown and a new government will expropriate the property, with no compensation. The full $25 million would be lost, and the internal rate of return would be -100 percent. There also is a 15 percent probability that the government will be overthrown but that the new government will make a partial payment for the properties. This situation would result in an internal rate of return of -40 percent. Finally, there is a 15 percent probability that the present government will stay in power but that it will change its policy on repatriation of profits. More specifically, it will allow the corporation to repatriate its original investment, $25 million, but all other cash flows generated by the project would have to be reinvested in the host country forever. These probabilities still leave a 60 percent chance that a 34 percent internal rate of return will be achieved.
Given these political risks, approximate the likely return to Comstock. Should the mining venture be undertaken? Explain.