Advanced Corporate Finance

Case Study

Ginny's Restaurant: An Introduction to Capital Investment Valuation by Mark

Mitchell

Candidates: Mladenka Vuchkova; Sanja Pavel

Professor: Vittorio De Pedys

Co-teacher: Stefan Tanevski

June 2020, Skopje

Virginia’s current wealth

Calculation of present value of assets entails discounting future cash flows at the

required rate of return. Present value represents the equivalent of future expected cash

flows. The table below shows present value for Virginia’s assets.

Period Asset Amount PVIF @6% Present Value

0  $    2,000,000.00 1.0000  $      2,000,000.00
1  $    3,000,000.00 0.9434  $      2,830,188.68
    Total  $      4,830,188.68
Therefore, Virginia can spend only $ 2 million today. Future funds cannot be spent

before acquisition.

On the contrary, if she foregoes consumption, the computation below represents

the amount of disposable income available to her after a year.

Period Asset Amount FVIF @6% Future Value

1  $    2,000,000.00 1.0600  $          2,120,000.00
0  $    3,000,000.00 1.0000  $          3,000,000.00
    Total  $          5,120,000.00

Investment analysis

Using NPV, the best investment amount is $ 3 million since it yields the highest

NPV. An investment of $ 1 million has the highest returns when evaluated based on

internal rate of return and profitability index.

Investing in Ginny’s Restaurant generates a higher return for assets and therefore

Virginia’s wealth raises.

NPV      
Investment Future Cash PV of Cash
NPV
(outflow) flow flow
 $        $         $      $     

1,000,000.00 1,800,000.00 1,698,113.21 698,113.21

 $        $         $      $  
 2,000,000.00 3,300,000.00 3,113,207.55 1,113,207.55
 $        $         $      $  

3,000,000.00 4,400,000.00 4,150,943.40 1,150,943.40

 $        $         $      $  

4,000,000.00 5,400,000.00 5,094,339.62 1,094,339.62

       
IRR      
Investment Future Cash
IRR  
(outflow) flow
 $       $       
80%  
-1,000,000.00 1,800,000.00
 $       $       
65%  
-2,000,000.00 3,300,000.00
 $       $       
47%  
-3,000,000.00 4,400,000.00
 $       $       
35%  
-4,000,000.00 5,400,000.00
       
PI      
Investment Future Cash PV of Cash
PI
(outflow) flow flow
 $        $         $    
1.70
1,000,000.00 1,800,000.00 1,698,113.21
 $        $         $    
1.56
2,000,000.00 3,300,000.00 3,113,207.55
 $        $         $    
1.38
3,000,000.00 4,400,000.00 4,150,943.40
 $        $         $    
1.27
4,000,000.00 5,400,000.00 5,094,339.62

Simplified Balance sheet for Virginia as of today

Assets

Non-current assets                                          $         

Investment in Ginny’s Restaurant                  3000000

 Current Assets

Cash at hand                                                   1000000

Total assets                                                      4000000

Liabilities and equity

Shareholders’ funds                                        4000000

Consumption of $ 3.8 million immediately cannot be achieved under the available

circumstances and plans for investment. Only $ 3 million maximum is available for

immediate consumption.

Financing the investment in Ginny’s restaurant using a bank loan.

Capital rationing occurs when sources of free cost capital are exhausted. The best

valuation technique in this scenario is profitability index. PI captures the cost of capital in

evaluating the viability of a project. Virginia should borrow $ 1 million bank loan to invest

in the restaurant since it has the highest profitability index.

Savers versus Spenders

Savers will be willing to invest $ 3 million to benefit from the higher yields resulting

from the highest NPV. On the contrary, spenders will maximize their current consumption

and opt for an investment of $ 1 million to benefit from the highest internal rate of return

and a higher profitability index.

A compromise will arise on the basis of investing the raised funds. Spenders

would prefer quick returns while savers prefer steady long term income in form of

dividends.

Selling smoked hams via internet

Investment $ 2.5 million

Future cash flow $ 3.4 million

 NPV = (3.4*0.9434) - 2.5

= $ 707,560

The investment should be undertaken since it has a positive NPV. New balance sheet

after the investment assuming capital increase.

Assets                                                  $

Investment in smoked hams               2500000

Investment in Ginny’s restaurant        3000000

Cash                                                    1000000                                             

Total assets                                          6500000

Liabilities and equity

Shareholders’ funds                            6500000

Price of a share before = $ 4000000/200000

                                  = $ 20

Price of a share after = $ 6500000/200000

                                   = $ 32.5