Corporate Finance

INSTRUCTOR: Mr. Konstantinos Kanellopoulos, MSc (L.S.E.), M.B.A.

COURSE: MBA-680-50-SUII12 Corporate Financial Theory

SEMESTER: Summer Session II

Case Study

Investment, Strategy & Economic Rents

(solutions)

Konstantinos Kanellopoulos

13th August 2012

CASE STUDY I

Taxes are a cost, and, therefore, changes in tax rates can affect consumer prices, project lives, and the value of existing firms. The following problem illustrates this. It also illustrates that tax changes that appear to be “good for business” do not always increase the value of existing firms. Indeed, unless new investment incentives increase consumer demand, they can work only by rendering existing equipment obsolete.

The manufacture of bucolic acid is a competitive business. Demand is steadily expanding, and new plants are constantly being opened. Expected cash flows from an investment in a new plant are as follows:

|  |0 |1 |2 |3 |

|1. Initial investment |100 | | |  |

|2. Revenues | |100 |100 |100 |

|3. Cash operating costs | |50 |50 |50 |

|4. Tax depreciation | |33,33 |33,33 |33,33 |

|5. Income pretax | |16,67 |16,67 |16,67 |

|6. Tax at 40% | |6,67 |6,67 |6,67 |

|7. Net income | |10 |10 |10...