Question

2 Franchise Value

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

2)	(a)
	Profit each year =			400000
	Salvage value (At t=3)			500000000
	Interest rate =			4%
	To break even the PV of cash outflow should be equal to PV of Cash inflow
	PV of Cash outflow =		Cost of Mavericks
	PV of Cash Inflow =
	Year	Cash flow	PV Factor @ 4%	PV of Cashflow
	1	400000	0.96153846	384615.38
	2	400000	0.92455621	369822.49
	3	400000	0.88899636	355598.54
	3	500000000	0.88899636	444498179
				445608216
	Price to be paid to breakeven =			445608216
	(b)
	Profit each year =			400000
	Price of Mavericks =			285000000
	Interest rate =			4%
	To break even the PV of cash outflow should be equal to PV of Cash inflow
	PV of Cash outflow =		Cost of Mavericks
	PV of Cash Inflow =
	Year	Cash flow	PV Factor @ 4%	PV of Cashflow
	1	400000	0.96153846	384615.38
	2	400000	0.92455621	369822.49
	3	400000	0.88899636	355598.54
	3	x (Let)	0.88899636	0.888996 x
				1110036.4
				+0.888996 x
	Salvage value to break even =			0.888996 x
	1110036	+0.888996 x	= 285000000
		0.888996 x =	283889964
		x =	283889964/0.888996
			319337600
	(c )
	Profit each year =			x
	Salvage value (At t=3)			500000000
	Interest rate =			4%
	Price of Mavericks =			285000000
	To break even the PV of cash outflow should be equal to PV of Cash inflow
	PV of Cash outflow =		Cost of Mavericks
	PV of Cash Inflow =
	Year	Cash flow	PV Factor @ 4%	PV of Cashflow
	1	x	0.96153846	0.9615385 x
	2	x	0.92455621	0.9245562 x
	3	x	0.88899636	0.8889964 x
			2.77509103	2.775091 x
	3	500000000	0.88899636	444498179
		285000000 =	2.775091 x + 444498179
		x=	(285000000 - 444498170)/2.775091
		x=	-159498179	/2.775091
		x=	-57474936
	Please provide feedback…. Thanks in advance…. :-)