Zircon, a Unites States (US) based multinational company, is considering a project that will sell the use of its technology to firms in Argentina. It has already received orders from Argentinean firms that will generate 3 million Argentinean pesos (ARS) in revenue within one year (i.e. end of year 1) of starting the project. However, it might also receive a contract to provide this technology to the Argentinean government. In this case, it will generate a total of ARS $5,000,000 within one year of starting the project (i.e. end of year 1). It will not know whether it will receive the government order until the end of the current year (i.e. end of year 1).
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Today’s spot rate (i.e. time 0 or beginning of year 1) of the peso is US$0.14. The one-year forward rate is US$0.12 (i.e. the current forward price for exchange at the end of year 1). Zircon expects that the spot rate of the peso will be US$0.13 one year from now (i.e. end of year 1). The only initial outlay (i.e. at time 0 or beginning of year 1) will be US$300,000 to cover development expenses, regardless of whether the Argentinean government purchases the technology or not. It will pursue the project only if it can satisfy its required rate-ofreturn of 18 percent. Ignore possible tax effects and assume that cash inflows, if they materialise, occur a year from the initial investment in the project (i.e. end of year 1).
Address the following:
1. It decides to hedge the maximum amount of revenue that it will receive from the project.
a. Determine the net present value (NPV) if Zircon receives the government contract.
b. If Zircon does not receive the contract, it will have hedged more than it needed to and will offset the excess forward sales by purchasing pesos in the spot market at the time the forward sale is executed. Determine the NPV of the project assuming that Zircon does not receive the government contract.
2. Now consider an alternative strategy in which Zircon only hedges the minimum peso revenue that it will receive. In this case, any revenue due to the government contract would not be hedged.
a. Determine the NPV based on this alternative strategy and assume that Zircon receives the government contract.
b. Determine NPV under the alternative strategy and assume that Zircon does not receive the government contract.
3. As the financial manager of Zircon, describe the uncertainty that surrounds the estimate of future cash flows from the perspective of the US parent.
4. As the financial manager for Zircon, explain how you propose to take account of risk in evaluating whether to proceed with this project.
– 2500 words (plus or minus 10%).
– Must have Executive Summary, Introduction, Body and/or Recommendation, Conclusion and at least 6 References.