Question

A British multinational anticipates cash flows of 100 mln GBP, 120 mIn GBP and 160 mln GBP, respectively, for the first three years of a project in Russia. The initial investment is 790 min GBP. The firm expects perpetuity of 200 min GBP in years 4 and beyond. If the required return on the investment is 17 per cent, how large does the probability of expropriation in year 5 have to be before the investment breaks even in NPV terms? Assume that the total cash flow in year 5 in the event of expropriation is equal to 360 mln GBP. Exercise 4

Answer 1

Year	CF
0	-790
1	100
2	120
3	160
4	1376.471
5	-360
NPV	$53.38

Cash Flow in year 4 = 200 + 200 / 17% = $1376.47 m

If expropriation is equal to 360 in year 5, NPV = 53.38 which can be calculated as shown below:

NPV = - 790 + 100 / 1.17 + 120 / 1.17^2 + ... - 360 / 1.17^5 = 53.38

Now, we need to find the expropriation in year 5 such that NPV = 0

If expropriation in year 5 = 360 + 53.38 x 1.17^5 = 477.04, then NPV = 0.