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.

(b) “PPI is presently within the zone of insolvency.” True or false? Why?

(c) In consideration of your responses to parts (a) and (b) above, should the PPI Board move forward with the investment? Why or why not?

If you cannot answer (b) and (c) that's okay. Please help me with (a) at least, especially in the perspective of the creditors

Answer 1

Based on the given data, would like to chart out below the key parameters:

Investment Proposed = $ 10 Mn

Revenue from Successful implementaion = $ 100 Mn; Probability of Success = 25%;

Probability of crop ravage and resulting in $ 100 Mn loss = 5%;

Importantly,

Total Assets = $ 110 Mn

Total Liabilities = $ 120 Mn ( entire liabilites to Credit Potato);

The above status of assets and liabilities shows that the business is currently having NEGATIVE NETWORTH of $ 10 Mn

Perspectives as below:

While the Management shall consider based on the given possible probable factors and the likelihood of happenings/ not happenings of the events, the creditors look more from the conservative angle.

In this case, since the company's net worth is already negative, with total liabiliites to Credit Potato, it can be looked at a perspective of additional stress on the networth if this investment is made with such low probabilities; Creditors perspective shall be mainly from the cash flow loss from the investments, as they expect that any investment shall generate cash flows and the same could be used by the firm to pay their dues/overdues. In this case, the total value of investment and further cash flows from the project are looked at by the Cerdit Potato in most extreme conservative approach.

Investment	10		$ Mn
Revenue	100	25%	25
Ravage Loss	100	5%	5
Net Income			20
	Likelihood	70%	14
Investment	10		$ Mn
Revenue	100	0%	0
Ravage Loss	100	5%	5
Net Income			-5
From Creditors Perspective		-15

Q) “PPI is presently within the zone of insolvency.” True or false? Why?

Ans) The answer is TRUE; Currently, the firm's networth is negative and is having a single Creditor to be paid for.

Q) In consideration of your responses to parts (a) and (b) above, should the PPI Board move forward with the investment? Why or why not?

Ans) Given the situation, it is not recommended for this investment option as there is very lower probabilities for this investment to generate income and also having the changes of ravaging the existing crop. With already in a negative networth situation, it is not advisable for the firm for such investments with lower happening probabiliites.