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ACCA Strategic Professional · Advanced Financial Management · International investment and financing decisions

When assessing country risk before a foreign direct investment, which approach adjusts the project's cash flows for specific political events rather than simply raising the discount rate?

Scenario-based expected cash flow adjustment changes the projected cash flows to reflect specific political events with probabilities. It differs from adding a country risk premium to the discount rate, which penalises all later cash flows uniformly, and from credit ratings or purchasing power parity.

  1. AScenario-based expected cash flow adjustmentCorrect
  2. BIncreasing the discount rate by a country risk premium
  3. CUsing only the host country's credit rating
  4. DApplying purchasing power parity to the exchange rate

Explanation

Adjusting cash flows through probability-weighted scenarios models specific events such as blocked funds, and avoids the criticism that a higher discount rate penalises distant cash flows uniformly. The other options either adjust the rate, rely on a rating, or relate to exchange rates.

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