Larry Armstrong, the president of Columbia Fried Chicken, a fast food chain, is determining whether or not to purchase insurance through OPIC for a new capital investment in Bolivia. It is not clear if the current Bolivian president can reverse the decades of deterioration that preceded the collapse of the Bolivia. The original analysis of the project assumed Bolivian president would be able to resolve inter-class tensions that had left the country tottering toward anarchy. Now communists are creating instability, and there seems a 50-50 chance that the government will be overthrown.
After reading various political risk assessments, Armstrong concludes that if the Bolivian government falls, the probability of expropriation is 100%. If expropriated, he judges the probability of 20% for full compensation immediately, 30% probability for a two-year delayed compensation of only 30% of the $2.5 million equity value, and 50% probability for no compensation at all. Columbia Fried Chicken's equity in Bolivia is $2.5 million. Its weighted average cost of capital is 16%, and OPIC charges $0.80 per $100 coverage. OPIC would pay immediately on any expropriation (any subsequent compensation from the Bolivian government will be handed over to OPIC). Should Armstrong purchase OPIC insurance?
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• Briefly explain what Internalization theory is, in the context of foreign direct investment.