Mom and Pop Groceries has just dispatched a years supply of groceries to the government of the

QUESTION

Mom and Pop Groceries has just dispatched a years supply of groceries to the government of the Central Antarctic Republic. Payment of $250,000 will be made one year hence after the shipment arrives by snow train. Unfortunately there is a good chance of a coup dA?tat, in which case the new government will not pay. Mom and Pops controller therefore decides to discount the payment at 40 percent, rather than at the companys 12 percent cost of capital.a. Whats wrong with using a 40 percent rate to offset political risk?b. How much is the $250,000 payment really worth if the odds of a coup dA?tat are 25 percent?
1. The threat of coup d etat means that the expected cash flow is less than $250,000. The threat could also increase the discount rate, but only if it increases the market risk 2. The expected cash flow is

0.25×0)+(0.75×250,000)=$187,500 Assuming that the net cash flow is about as risky as the rest of the companys business: PV=$187,500/1.12=$167,411

ANSWER:

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