Ginny's Restaurant Case Study

Executive Summary of Ginny’s Restaurant

#1

Virginia will receive $2 million today and $3 million one year from today. As such, using the current interest rate of 6% as a discount rate, her current wealth can be calculated to be $4.83 million. This is the sum of the $2 million she already has in hand and the present value of the $3 million she is to receive one year from now.

$2,000,000+ $3,000,000(1+.06) =$4,830,188.68

Virginia can spend and consume just the $2,000,000 she presently has, or she can take a one year loan in the amount of $2,830,188.68 (the present value of the $3,000,000 to be received in one year) and spend that as well. When she receives the $3,000,000 in one year, she will use those proceeds to pay off the principal and accrued interest on the loan.

If however, Virginia should decide to spend nothing today and deposits the $2 million, she will have $2,120,000 in one year plus the additional $3,000,000 for a total of $5,120,000.

#2

Virginia is to receive a single $4 million endowment instead of the two-period endowment, part of which she wishes to invest into Ginny’s Restaurant. By comparing the sum of expected cash flows from the restaurant in one year and the return from depositing the balance, one can determine the optimal allocation between the two options.

Invest Today | Future CF | Deposit in Bank | Interest Earned | Wealth in 1 yr | Total Gain $ | Total Gain % |

1,000,000 | 1,800,000 | 3,000,000 | 180,000 | 4,980,000 | 980,000 | 24.50% |

2,000,000 | 3,300,000 | 2,000,000 | 120,000 | 5,420,000 | 1,420,000 | 35.50% |

3,000,000 | 4,400,000 | 1,000,000 | 60,000 | 5,460,000 | 1,460,000 | 36.50% |

4,000,000 | 5,400,000 | 0 | 0 | 5,400,000 | 1,400,000 | 35.00% |

Based on this evaluation, Virginia should invest $3 million into the restaurant and deposit the remaining $1 million to maximize her return.

(#2 continued next page)

Another way of looking at this would be to consider the present value of the...