Blustream, Inc., considers a project in which it will sell the use of its technology to firms in Mexico.

It already has received orders from Mexican firms that will generate 3 million Mexican pesos
(MXP) in revenue at the end of the next year. However, it might also receive a contract to provide
this technology to the Mexican government. In this case, it will generate a total of MXP5 million
at the end of the next year. It will not know whether it will receive the government order until
the end of the year.
Today’s spot rate of the peso is $.14. The 1-year forward rate is $.12. Blustream expects that the
spot rate of the peso will be $.13 1 year from now. The only initial outlay will be $300,000 to cover
development expenses (regardless of whether the Mexican government purchases the
technology). Blustream will pursue the project only if it can satisfy its required rate of return of
18 percent. Ignore possible tax effects. It decides to hedge the maximum amount of revenue that
it will receive from the project.
a. Determine the NPV if Blustream receives the government contract.
b. If Blustream does not receive the contract, it will have hedged more than it needed to and
will offset the excess forward sales by purchasing pesos in the spot market at the time the
forward sale is executed. Determine the NPV of the project assuming that Blustream does
not receive the government contract.
c. Now consider an alternative strategy in which Blustream only hedges the minimum peso
revenue that it will receive. In this case, any revenue due to the government contract would
not be hedged. Determine the NPV based on this alternative strategy and assume that
Blustream receives the government contract.
d. If Blustream uses the alternative strategy of only hedging the minimum peso revenue that
it will receive, determine the NPV assuming that it does not receive the government
contract.
e. If there is a 50 percent chance that Blustream will receive the government contract, would
you advise Blustream to hedge the maximum amount or the minimum amount of revenue
that it may receive? Explain.
f. Blustream recognizes that it is exposed to exchange rate risk whether it hedges the
minimum amount or the maximum amount of revenue it will receive. It considers a new
strategy of hedging the minimum amount it will receive with a forward contract and
hedging the additional revenue it might receive with a put option on Mexican pesos. The 1-
year put option has an exercise price of $.125 and a premium of $.01. Determine the NPV if
Blustream uses this strategy and receives the government contract. Also, determine the
NPV if Blustream uses this strategy and does not receive the government contract. Given
that there is a 50 percent probability that Blustream will receive the government contract,
would you use this new strategy or the strategy that you selected in question (e)?