Question

2 Franchise Value ( Show all work)

a) Suppose that Mark Cuban wants to purchase the Mavericks in 2000 (call this year 0), and he expects to receive $400,000 in profits in years 1, 2, and 3 (each year). Now suppose that value of the Mavericks in year 3 is $500 million and that the interest rate is 4%. What is price that Mark would pay to make him break even in 3 years (i.e. that makes E[B] – p =0)?

b) Now, suppose that Mark Cuban plans to purchase the Mavericks in 2000 for $285 million and he expects to receive $400,000 in profits in years 1, 2, and 3 (each year). Now suppose that the interest rate is 4%. What would be the value of the Mavericks in 3 years that would make Mark break even?

c) Finally suppose Mark plans to purchase the Mavericks at $285 million in 2000. The value of the mavericks will be $500 million in 3 years and the interest rate is 4%. Suppose the expected profits for years 1, 2, and 3 is x (i.e. Mark expects to receive x in year 1, x in year 2, and x in year 3). What is value of x that would make Mark break even?

Answer 1

Answer to part a:

Present value of profit Mark receives each year:

Year	Year1	Year 2	Year 3
Profit	400000	400000	400000
Present Value	384615.4	369822.5	355598.54

Present value of the money he receives when he sells:

500000000/(1+0.04)^3 = 444498179

​Present value of total earning: 445608215.7 , for him to break even, this is the price he must pay

Answer to part b

Price Mark is ready to pay - $ 285,000,000

As in part a the present value of cash flows will be 1110036.4

So the Mavericks should have  $283, 889,964 *(1+0.04)^3 = $ 319,337,600 , for him to break even

c)

This question now asks you to calculate the profit he should make each year for him to break even.

Solving the equality

500 million /(1+0.04)^3 + x*(1/(1+0.04)^3+1/(1+0.04)^2+1/(1+0.04))) - 285million= 0 gives the value

$ - 57474935.93, which means that even if he makes a loss of 57.47 milllion loss per year, he will still break even