Question

The Board of Directors of Potato Pave Inc. (PPI) is considering a $10 million dollar investment in new molecular biology technology that will enable PPI to, if successful, grow and produce potato plants of improved varieties and at a faster rate compared to conventional potato farming technologies. The successful implementation of this new technology is expected to bring in $100 million for PPI, and the likelihood of such success is 25%. There is a 5% chance the technology will ravage PPI’s current potato crop, and result in additional losses of $100 million dollars to PPI. The Board believes that the most likely scenario (with a 70% likelihood) is that the technology will yield just enough value to offset the $10 million expended to invest in the technology. PPI today has $110 million of total assets and $120 million of total liabilities (its liabilities are to a single creditor, Credit Potato). Assume all dollar amounts are present values and impact PPI’s balance sheet.

(a) (10%) What is the expected value of the prospective investment from the perspectives of (i) the corporate enterprise, PPI, and (ii) its single creditor, Credit Potato? Show the process of calculation.

Answer 1

Expected value of the prospective investment from the perspectives of

(i) the corporate enterprise, PPI

Initial Investment + PV of Expected cash Inflows

ie.   -10 +((100*25%)+(-100*5%)+(10*70%))=

17

mlns.

(ii) its single creditor, Credit Potato

we will analyse using the balance sheet , before & after the investment & its consequences

Balance sheet before Investment
Assets		Liabilities & equity
Assets	110	Credit Potato	120
		Equity	-10
Total assets	110	Total Liab.& equity	110

Balance sheet after Investment
Assets		Liabilities & equity
Assets = 110-10 investment(cash spent)	100	Credit Potato (Bal.fig.)	110
NPV created	17	Equity---- (-10+17 NPV)	7
Total assets	117	Total Liab.& equity	117
So, the Creditor's perspective =120-110=    $ 10 mlns