Question

Wentworth Co. is planning a project in France. It would lease space for one year in a shopping mall to sell expensive clothes manufactured in the U.S. The project would end in one year, when all earnings would be remitted to Wentworth Co. Assume that no additional corporate taxes are incurred beyond those imposed by the French government. Since Wentworth Co. would rent space, it would not have any long-term assets in France, and expects the salvage (terminal) value of the project to be about zero.  

Assume that the project’s required rate of return is 20 percent. Also assume that the initial outlay required by the parent to fill the store with clothes is $300,000. The pretax earnings are expected to the €500,000 at the end of one year. The euro is expected to be worth $1.16 at the end of one year, when the after-tax earnings are converted to dollars and remitted to the United States. The following forms of country risk, which are independent, must be considered:

* The French economy may weaken (probability = 35%), which would cause the expected pretax earnings to be €400,000.

* The French corporate tax rate on income earned by U.S. firms may increase from 30 percent to 40 percent (probability = 30 percent).

       -$16,815
       -$18,265
       $1,165
       $2,375

Answer 1