Ginny's Restaurant: An Introduction to Capital Investment Valuation

Ginny's Restaurant: An Introduction to Capital Investment Valuation

(1) Present Consumption = C0 + C1/(1+0.06)1

Future Consumption = C0*(1+0.06)1 + C1

Present Consumption (Wealth) $4,830,188.68

Future Consumption $5,120,000.00

Virginia's current wealth is $4.83 million. She can spend and consume that amount today. She can spend and consume $5.12 million one year from today if she consumes nothing today.

(2)

Amounts are in Millions

Investment (today) Future Cash Flow (end of year) Amount Not Invested Wealth Percent Return

$1.00 $1.80 $3.00 $4,698,113.21 17.45%

$2.00 $3.30 $2.00 $5,113,207.55 27.83%

$3.00 $4.40 $1.00 $5,150,943.40 28.77%

$4.00 $5.40 $0.00 $5,094,339.62 27.36%

Wealth = Current Amount of Endowment Remaining + PV of Future Cash Flow of the Investment

Virginia should invest $3 million of the initial endowment into the restaurant. She'll have $1 million of the endowment remaining. This option provides her with the highest amount of wealth. Her initial wealth of $4 million increases to $5.15 million with this investment (28.8% increase). The only other consideration is Virginia's preference for consumption now versus consumption later, which might influence the amount of money invested today.

(3) Virginia consumes $3.8 million today.

Amounts are in Millions

Investment Future Cash Flow (end of year) Amount of Borrowed Money Amount of Money Owed on Loan in 1 year Current Wealth (minus the $3.8 million she consumes today)

$1.00 $1.80 $0.80 $0.85 $898,113.21

$2.00 $3.30 $1.80 $1.91 $1,313,207.55

$3.00 $4.40 $2.80 $2.97 $1,350,943.40

$4.00 $5.40 $3.80 $4.03 $1,294,339.62

Assuming that Virginia is going to invest $3 million of her $4 million endowment into Ginny's Restaurant (per answer to question 2), it is still possible for her to consume $3.8 million immediately. Using the remaining $0.2 million from her endowment and borrowing $2.8 million from the bank at an interest rate of 6%, her current wealth is still $1.35 million after investing in the restaurant.

(4) Assumptions: Markets are perfect; Cash Flows are know with certainty; 6% interest rate; World lasts only one year.

Amounts are in Millions

Investment Future Cash Flow (end of year) Amount of Borrowed Money Amount of Money Owed on Loan in 1 year Current Wealth

$1.00 $1.80 $1.00 $1.06 $698,113.21

$2.00 $3.30 $2.00 $2.12 $1,113,207.55