Brooks Co. (a U.S. firm) considers a project in which it will have computer software developed. It would sell the software to Razon Co., an Australian company, and would receive payment of 10 million Australian dollars (A$) at the end of 1 year. To obtain the software, Brooks would have to pay a local software producer $4 million today. Brooks Co. might also receive an order for the same software from Zug Co. in Australia. It would receive A$4 million at the end of this year if it receives this order, and it would not incur any additional costs because it is the same software that would be created for Razon Co.
The spot rate of the Australian dollar is $.50, and the spot rate is expected to depreciate by 8 percent over the next year. The 1-year forward rate of the Australian dollar is $.47. If Brooks decides to pursue this project (have the software developed), it would hedge the expected receivables due to the order from Razon Co. with a 1-year forward contract, but it would not hedge the order from Zug Co. Brooks would require a 24 percent rate of return in order to accept the project.
a. Determine the net present value of this project under the conditions that Brooks receives the order from Zug and from Razon and that Brooks receives payments from these orders in 1 year.
b. Brooks recognizes there are some country risk conditions that could cause Razon Co. to go bankrupt. Determine the net present value of this project under the conditions that Brooks receives both orders but that Razon goes bankrupt and defaults on its payment to Brooks.