1. How country risk affects NPV. Monk Ltd is con- sidering a capital budgeting project in Tunisia. The project requires an initial outlay of 1 million Tunisian dinar; the dinar is currently valued at £0.48. In the first and second years of operation, the project will generate 700 000 dinar in each year. After two years, Monk will terminate the project, and the expected salvage value is 300 000 dinar. Monk has assigned a discount rate of 12% to this project. The following additional information is available:

l There is currently no withholding tax on remittan- ces to the United Kingdom, but there is a 20% chance that the Tunisian government will impose a withholding tax of 10% beginning next year.

l There is a 50% chance that the Tunisian govern- ment will pay Monk 100 000 dinar after two years instead of the 300 000 dinar it expects.

l The value of the dinar is expected to remain unchanged over the next two years.

a Determine the net present value (NPV) of the project in each of the four possible scenarios.

b Determine the joint probability of each scenario.

c Compute the expected NPV of the project and make a recommendation to Monk regarding its feasibility.

2. How country risk affects NPV. In the previous question, assume that instead of adjusting the estimated cash flows of the project, Monk had decided to adjust the discount rate from 12% to 17%. Re-evaluate the NPV of the project's expected scenario using this adjusted discount rate.