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Managerial Finance



1.BACI RESTAURANT

Roberta will receive $2 million today and 3$ million one year from today. Roberta does not have other assets. There are no transaction costs or taxes, and all potential creditors and debtors have all relevant information about investment payoffs. In addition, assume that all future cash flows are known with certainty. For simplicity, assume that Roberta lives in a world that lasts one year, and the rate of interest is 6%.

1.What is Roberta’s current wealth (equivalently, what is the present value of her assets?) How much money can she spend and consume today? How much of the money can she spend and consume one year from today if she consumes nothing today?

Cash on hand: $2 million
Cash to be received 1 year from now: $3 million

The present value of the present and future cash flow is: Co + C1/1+r = 2 + 3/1.06 = $4.83 million

Equivalently, the amount that Roberta can consume today is $4.83 million. She can consume today, additionally to the $2 million, an amount of $2.83 million borrowed against the $3million future cash flow.

If Roberta decides not to spend anything today, she will lend the $2 million against a future value of $2.12 million ($2 * 1.06) and she will be able to consume one year from now an amount of $3+$2.12=$5.12 million.

Suppose that instead of having a two period endowment, Roberta has an initial endowment of $4 million. She decides to invest part of the $4 million in an Italian restaurant, Baci, which she will build and manage. The data below indicates the future cash flows (end of the year) that will result from an investment today. All payoffs are completely certain and known to all.

2.How much of the $4 million should Roberta invest in the restaurant? What happens to Roberta’s wealth when she makes the investment in Baci Restaurant?

Analyzing the NPVs of the four projects Roberta will realize that the project adding the highest value to her company is project C. Therefore she should invest in...