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Hart Venture Capital (HVC) specializes in providing venture capital for software development and Internet applications. Currently...

Hart Venture Capital (HVC) specializes in providing venture capital for software development and Internet applications. Currently HVC has two investment opportunities: (1) Security Systems, a firm that needs additional capital to develop an Internet security software package, and (2) Market Analysis, a market research company that needs additional capital to develop a software package for conducting customer satisfaction surveys. In exchange for Security Systems stock, the firm asked HVC to provide $600,000 in year 1, $600,000 in year 2, and $250,000 in year 3 over the coming three-year period. In exchange for Market Analysis stock, the firm asked HVC to provide $500,000 in year 1, $350,000 in year 2, and $400,000 in year 3 over the same three-year period. HVC believes that both investment opportunities are worth pursuing. However, because of other investments, HVC is willing to commit at most $800,000 for both projects in the first year, at most $700,000 in the second year, and $500,000 in the third year. HVC’s financial analysis team reviewed both projects and recommended that the company’s objective should be to maximize the net present value of the total investment in Security Systems and Market Analysis. The net present value takes into account the estimated value of the stock at the end of the three-year period as well as the capital outflows that are necessary during each of the three years. Using an 8% rate of return, HVC’s financial analysis team estimates that 100% funding of the Security Systems project has a net present value of $1,800,000, and 100% funding of the Market Analysis project has a net present value of $1,600,000. HVC has the option to fund any percentage of the Security Systems and Market Analysis projects. For example, if HVC decides to fund 40% of the Security Systems project, investments of would be required in year 1, would be required in year 2, and would be required in year 3. In this case, the net present value of the Security Systems project would be . The investment amounts and the net present value for partial funding of the Market Analysis project would be computed in the same manner. Managerial Report Perform an analysis of HVC’s investment problem and prepare a report that presents your findings and recommendations. Be sure to include information on the following: The recommended percentage of each project that HVC should fund and the net present value of the total investment A capital allocation plan for Security Systems and Market Analysis for the coming three-year period and the total HVC investment each year The effect, if any, on the recommended percentage of each project that HVC should fund if HVC is willing to commit an additional $100,000 during the first year A capital allocation plan if an additional $100,000 is made available Your recommendation as to whether HVC should commit the additional $100,000 in the first year

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Solutions

Expert Solution

Year 0 1 2 3 Year 3
Security Systems stock 600000 600000 250000
PV f at 8% 0.92593 0.85734 0.79383
555556 514403 198458
NPV of 3-Yr. cash flows at 8% 1268417
NPV(incl. value of the co.'s stock) 1800000
Value of stock at end Yr.3
(1800000-1268417)*1.08^3= 669641
40% funding
240000 240000 100000 267856
0.92593 0.85734 0.79383 0.79383
222222 205761 79383 212633
NPV of 3-Yr. cash flows+40% value of the Co. stock at Yr.3) at 8% 720000
Market Analysis stock 500000 350000 400000
0.92593 0.85734 0.79383
462963 300069 317533
NPV of 3-Yr. cash flows at 8% 1080564
NPV(incl. value of the co.'s stock) 1600000
Value of stock at end Yr.3
(1600000-1080564)*1.08^3= 654340
40% funding
200000 140000 160000 261736
0.92593 0.85734 0.79383 0.79383
185185 120027 127013 207774
NPV of 3-Yr. cash flows+40% value of stock at end Yr.3) at 8% 640000
HVC recommended total funding 800000 700000 500000
Security Systems stock -100% 600000 600000 250000
Market Analysis stock 200000 100000 250000
Against Market Analysis stock 100% 500000 350000 400000
So, % 0f Market Analysis funding 40% 29% 63%
taking minimum of three(ie 29%) 145000 101500 116000
Value of stock at end yr. 3 189759 (654340*29%)
Total 145000 101500 305759
0.92593 0.85734 0.79383
134259 87020 242721
NPV of 3-Yr. cash flows+29% value of stock at Yr.3) at 8% 464000
Add: NPV of security systems stock(100% funding) 1800000
Total NPV 2264000
Additional $ 100000
HVC recommended total funding 900000 700000 500000
Security Systems stock -100% 600000 600000 250000
Market Analysis stock 300000 100000 250000
Against Market Analysis stock 100% 500000 350000 400000
So, % 0f Market Analysis funding 60% 29% 63%
taking minimum of three(ie 29%) 145000 101500 116000
Value of stock at end yr. 3 189759
Total 145000 101500 305759
0.92593 0.85734 0.79383
134259 87020 242721
NPV of 3-Yr. cash flows+29% value of stock at Yr.3) at 8% 464000
Add: NPV of security systems stock(100% funding) 1800000
Total NPV 2264000
Additional $ 100000 not necessary as the total NPV is going to reamin the same,
as funding for market analysis is still going to be 29% only.

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