Ginny's Restaurant

How does Virginia explain to her future partners how much money she is bringing in?

She will go to bank. The bank says 6% interest on the loan given!

3 = Borrow(1+ 0.06) -> The 3 M she would pay off the loan next year.

So Borrowed amount = 2.83 M.

The market is perfect capital market: So all information is present. The real probabilistic distribution is known to everybody.

How much can she spend atmost! Its 4.83 assuming perfect capital market. If banks are not there, then it would be just 2M.

Endowment: Receipt of certain amount of money.

Invest in Ginny's Time0 | Cash remaining T0 | Sell Ginnys T1 | Bank Deposit Value T1 | Total PV | Total FV | | | | | |

0 | 4 | 0 | 4.24 | 4 | 4.24 | | | | | |

1 | 3 | 1.8 | 3.18 | 4.698113208 | 4.98 | | | | | |

2 | 2 | 3.3 | 2.12 | 5.113207547 | 5.42 | | | | | |

3 | 1 | 4.4 | 1.06 | 5.150943396 | 5.46 | | VIRGINA's WEALTH TODAY: 5.15 |

4 | 0 | 5.4 | 0 | 5.094339623 | 5.4 | | HER WEALTH NEXT YEAR : 5.46 | |

VIRGINA's WEALTH TODAY: 5.15 |

HER WEALTH NEXT YEAR : 5.46 |

If she is not investing in the restaurant, then her max consumption today: 4M (her equity)

But if she is investing 3M today: Max Consumption: 5.15M

Q. 4 : She needs to invest in the restaurant, coz she can get a loan. At Time 0

ASSETS:

Cash = 0

Ginny’s= 4.4/1.06 = 4.15

LIABILITY + EQUITY

Liability = 3 M

Equity = 1.15

Coz Equity should be the highest in assessing the value needed to be invested in the restaurant!

At Time1

ASSETS:

Cash = 0

Ginny’s= 4.4

LIABILITY + EQUITY

Liability = 3.18 M

Equity = 1.22

This is an illustration of Miller and Modigliani Theory: What is the right size of the investment!

The decision can be separated from the decision on how you finance it.

a) Look at PV, FV, NPV

b) Then take a decision on how you finance it.

QQ-5: Shareholder meeting: how much of the shares to buy? How much to vote? Etc etc.

Spenders: Wants to maximize total Present value! : People can...