Question

Ginny’s Restaurant Problem

Ginny is endowed with $10 million and is deciding whether to invest in a restaurant. Assume perfect capital markets with an interest rate of 6%.

Investment Option	Investment (millions)	End of Year CFs (millions)
1	1	1.8
2	2	3.3
3	3	4.4
4	4	5.4

1. List 4 perfect capital market assumptions.

1.   _ ______

                                         

2.   _ ______

3.     ______

4.   _ ______

2. Which investment option should Ginny choose?

Ginny is actively pursuing another business venture as a ticket scalper. She estimates that for a $2 million investment in inventory she can resell her tickets for $6 million over the next year (cash flows realized in exactly one year).  Assume the same 6% interest rate.

3. What is the NPV of the Ticket Brokering venture?
4. What is the new value of Ginny’s Corporation?
5. Suppose Ginny does not want to use her own $2 million to start the new venture. Instead, she wants to raise equity capital by issuing 100,000 new shares. What price will new investors be willing to pay?
6. How many shares will need to be sold to outside investors?
7. How will your answer differ if Ginny is not guaranteed to resell the tickets for $6 million?

(ix)      According to Ginny’s prospectus, cash flows from ticket sales (net of expenses) are expected to follow the following distribution:

Prob	Outcome
0.2	$5M
0.5	$3M
0.3	-$2M

What is the new value of Ginny’s Corporation?

(x)       What price will new investors be willing to pay for Ginny’s shares?

Answer 1

i) Perfect Capital Market Assumption :

1) There are no transaction costs

2) Market is entirely efficient

3) Market information is easily available and accesible. There are no cost incurred for collecting information.

4) There are large number of buyer and seller. No one can influence the price of the product.

ii)

Clearly, Option 3 has the highes NPV of $1.15 million and hence, option 3 should be choosen.

iii) NPV of the project = Present Value of Future Cash flows - Initial Investment

= 6,000,000*(PVF at 6%, 2 years) - 2,000,000

= 6,000,000*(1/(1+0.06)^2) - 2,000,000

= 6,000,000*0.889 - 2,000,000

= 5,339,978.64 - 2,000,000 = $3,339,978.64

iv) New Value of Ginny's corporation

Net Value of the Project = Initial Investment + NPV = $5,339,978.64

As per terms, I will be able to answer only 4 parts. For rest parts you can post another question, will be grateful to help.

If you have any doubt, ask me in the comment section please.