Ginny's Restaurant Case Study

By

Ashish barapatre (13034)

Bhavik kothari (13035)

Aditya kapoor (13031)

Ankur gupta (13032)

INTRODUCTION• Virginia lives in a “perfect” world: No transaction costs No taxes Investors and lenders have same info All future cash flows are certain Discount rate is risk free (6%) Finite time horizon of one year then Virginia

returns to the “real world.”

Question 1 What is Virginia's current wealth (equivalently, what is the present value of her assets)?

    How much money can she spend and consume today?

$20,00,000

How much of the money cans she spend and consume one year from today if she consumes nothing today?

$21,20,000.00 $30,00,000 $51,20,000

Discount rate Today One year later

6% $20,00,000 $30,00,000

NPV $48,30,189

• 1) PV=2+3/1.06=2+2.83=4.832FV=2*1.06+3=2.12+3=5.122)3*1.06+1.8=4.982*1.06+3.3=5.421*1.06+4.4 =5.460+5.4 =5.4Invest 3 million in Ginny’s. Her wealth will be 5.46 million after one year.3) No, she has to reserve 3 million to invest according to her plan.4) R1 = (1.8-1)/1=0.8R2 = (3.3-2)/2=0.65R3 = (4.4-3)/3= 0.47R4 = (5.4-4)/4 = 0.35Because the max return rate is 0.8 by investing 1 million in Ginny’s, she should borrow 1 million dollar loan from bank.5)6)R = (3.4-2.5)/2.5=0.36 >R4(0.35). Yes, she should undertake i

• 1. Valuation of Virginia’s assetsa. Present value:

PV = $2,000,000 + $3,000,000/(1+0.06)1 = $2,000,000 + $2,830,189= $4,830,189

b. Future Value (1 year):

FV = 2,000,000(1+0.06)1 + 3,000,000= 2,120,000 + 3,000,000= 5,120,000

• . $1 million investmentPV = $1,800,000/(1+0.06)1 + $3,000,000= $1,698,113 + $3,000,000= $4,698,113

d. $2 million investmentPV = $3,300,000/(1+0.06)1 + $2,000,000= $3,113,208 + $2,000,000= $5,113,208

e. $ 3 million investmentPV = $4,400,000/(1+0.06)1 + $1,000,000= $4,150,943 + $1,000,000= $5,150,943

f. $4 million investmentPV = $5,400,000/(1+0.06)1 = $5,094,340

• Virginia’s optimal investment in the restaurant is $3 million, which give her a total of $5,150,943 at the end of year 1. This is approximately a 29% increase in her wealth.

• 3. PV of investment with $2.8m borrowed

FV = Restaurant Future Cash flows – [Principle(1+0.06)]= $4,400,000 – [$2,800,000(1.06)]= $4,400,000 - $2,968,000= $1,432,000PV = $1,432,000/1.06= $1,350,943

Assuming that Virginia can borrow the balance of the $3 million investment at a 6% interest rate, she should make the investment regardless.

• . PV of investment with $3m borrowed

FV = Restaurant Future Cash flows – [Principle(1+0.06)]= $4,400,000 – [$3,000,000(1.06)]= $4,400,000 - $3,180,000= $1,220,000= $1,220,000/1.06PV = $1,150,943

Yes, she should still make the investment as it will net her $1,150,000.

Question 2How much of the $4 million should Virginia invest in the restaurant?

Discount rate

Remaining wealth

Investment (today)

Future cash flow(end of year)

6%

NPV $46,41,509 $30,00,000 $10,00,000 $18,00,000

NPV $50,00,000 $20,00,000 $20,00,000 $33,00,000

NPV $49,81,132 $10,00,000 $30,00,000 $44,00,000

NPV $48,67,925 $0 $40,00,000 $54,00,000

What happens to Virginia's wealth when she makes the investment in Ginny's restaurant?

• $ 4 million grows to $5m if she invest $2m in Ginny's restaurant. In other words Virginia wealth grows $1million.

Question 3Suppose that Virginia has a strong preference for current versus future consumption, and would like to consume at least $3.8 million immediately. Is this consumption possible in light of the planned investment in Ginny's restaurant ?

• Yes it is possible. See the following NPV. All senarios become positive NPVs.

Discount rate

Own money (today)

Finance (today)

Investment (today)

Future cash flow (end of year)

Interest cost (end of year)

6%

NPV $6,52,830 $2,00,000 $8,00,000 $10,00,000

$18,00,000

$48,000

NPV $10,11,321

$2,00,000 $18,00,000

$20,00,000

$33,00,000

$1,08,000

NPV $9,92,453 $2,00,000 $28,00,000

$30,00,000

$44,00,000

$1,68,000

NPV $8,79,245 $2,00,000 $38,00,000

$40,00,000

$54,00,000

$2,28,000

Question 4assume that Virginia does not have the $4 million endowment to begin with , but still has the necessary skills to develop & operate Ginny's restaurant. Should she still make the investment in the restaurant , & if so ,how much? Assume that the only source of financing is a bank loan.

• Yes virginia should finance $2 m from a bank to invest in ginny’s resturant

Discount rate

Own money (today)

Finance (today)

Investment (today)

Future cash flow (end of year)

Interest cost (end of year)

6%

NPV $6,41,509 0 $10,00,000

$10,00,000

$18,00,000

$60,000

NPV $10,00,000

0 $20,00,000

$20,00,000

$33,00,000

$1,20,000

NPV $9,81,132 0 $30,00,000

$30,00,000

$44,00,000

$1,80,000

NPV $8,67,925 0 $40,00,000

$40,00,000

$54,00,000

$2,40,000

Question 5Individuals are of two types , savers and spenders. While all individuals prefer current consumption to future consumption all other things equal , spenders have a relatively higher preference for current consumption. What if Virginia shares her ownership interest in the Virginia corporation with a widely diffuse group of investors savers and spenders ? How much of the $4 million will the saver want to invest in the restaurant, and how much will the spenders want to invest . Will they reach a compromise, and if so what will it be ?

• Saver wants to invest $3,760,00 and keep $240,000 as dividend.

DISCOUNT RATE

OWN MONEY (TODAY)

FINANCE(TODAY)

INVESTMENT (TODAY)

FUTURE CASH FLOW(END OF YEAR)

INTEREST COST(END OF YEAR)

6%

NPV $6,98,113 $37,60,OOO

$0 $10,00,000 $18,00,000 $0

NPV $11,13,208 $37,60,000 $0 $20,00,000 $33,00,000 $0

NPV $11,50,943 $37,60,OOO

$0 $30,00,000 $44,00,000 $0

NPV $10,80,755 $37,60,OOO

$2,40,000 $40,00,000 $54,00,000 $14,400

DISCOUNT RATE

OWN MONEY (TODAY)

FINANCE(TODAY)

INVESTMENT (TODAY)

FUTURE CASH FLOW(END OF YEAR)

INTEREST COST(END OF YEAR)

6%

NPV $6,98,113 $10,00,000 $0 $10,00,000 $18,00,000 $0

NPV $11,13,208 $20,00,000 $0 $20,00,000 $33,00,000 $0

NPV $11,50,943 $30,00,000 $0 $30,00,000 $44,00,000 $0

NPV $10,94,340 $40,00,000 $0 $40,00,000 $54,00,000 $0

Question 6The Virginia corporation now consist of cash and Ginny's restaurant. Assume that Virginia is contemplating another

investment , namely to sell smoked hams via internet. This project will require a $2.5 million investment? Assume that she does not want to use internal cash to finance the investment, nor does she want to use debt financing. There are currently 200,000 shares

outstanding in the Virginia corporation.

• Virginia should undertake this investment as it will generate $566,038 positive NPV even after giving 6% of stock price as a

dividend.

Discount rate

Today One year later

6 %

Investment ($25,00,000)

CF $34,00,000

Dividend ($1,50,000)

($25,00,000) $32,50,000

NPV $5,66,038

Shares o/s Price per share

Dividend per share

dividends

200000 $12.50 $0.75 $1,50,000