Harvard Business School Case Study 1: Ginny’s Restaurant: An Introduction to Capital Investment Valuation

Lee Hathaway MMS 185: Managerial Finance Professor Veraldi

if she consumes nothing today. The net present value of Virginia’s assets is approximately $4. Considering the fact that she will receive an additional $3 million one year from today. This figure takes into account how much she could borrow today in order to have exactly $3 million to pay back one year from now.124 million depending on the compounding rate of an investment which yields an interest rate of 6%. Of course. plus the original $2 million she receives today. the maximum amount of money Virginia would be able to spend and consume one year from today would be between $5.124 million under daily compounding if she consumes nothing today and decides to let her money grow for a year. Thus. 2007 1. Table B displays these calculations in detail.September 13. Virginia has approximately $4.83 million dollars.12 million under annual compounding. These calculations are depicted in Table A. If Virginia invests her holdings at the 6% interest rate. This value was obtained from summing the $2 million Virginia receives today plus the present value of the $3 million she will receive exactly one year from now. the future value of her original assets will be $2. . and at best will be approximately $2.12 and $5.83 million dollars at her disposal to spend and consume today if she pleases. she will have a greater amount to spend in exactly one year.

the investment option she selects will depend on the strength of her preferences for consumption now. Thus. The calculations included in Table C demonstrate that Virginia achieves her highest net present value of approximately $5. My analysis shows that investing $3 million in Ginny’s restaurant today is the optimal investment decision for Virginia.78% increase. . and will provide a substantial amount of up-front capital and labor for the Ginny’s Restaurant. approximately a 28. by making the investment Virginia increases her current wealth and the present value of her assets by $1.15 million. from a net present value of $4 million (if she did nothing) to around $5.2. Virginia should only deviate from this investment option if her indifference curves or preferences are such that she favors consumption now over future consumption. Question three examines this situation in greater detail. In this instance.15 million when she invests $3 million and saves $1 million.939.150. This investment choice is supported by a high future cash flow.

her current wealth is $1. Even if they were to ask for a cut of Ginny’s Restaurant’s guaranteed future cash flow. and Virginia follows the same borrowing and consumption behavior. Calculations illustrated in Table C demonstrate that Ginny should consume the $3.8 million today. borrow $2. ideally she should invest $3 million into Ginny’s Restaurant. my analysis encourages Ginny to explore other lending options besides bank loans and possibly seek out borrowing money from family members or other supporters who would charge little or no interest.8 million. she remains profitable.3.15 million (not including the $1 million she didn’t invest) when she wasn’t governed by strong current consumption preferences to $1. and combine that amount with the remaining $0. In fact she has little difficulty repaying all of the principal and additional interest at the 6% rate since future cash flows are known with certainty in her world.40. Ginny would be able to avoid paying interest on the principal and could raise her current wealth closer to the original present value of her assets before she felt compelled to spend $3. Despite the fact that her current wealth decreases from approximately $4.8 million immediately. Although lending at these rates is a viable option.943.350.2 million of her endowment. Despite Virginia’s strong preference for current versus future consumption forcing her to consume at least $3. Based on the analysis performed in question two.2 million. the planned investment in Ginny’s Restaurant is still plausible and in fact profitable. for example 10%. Even if the interest rate were higher. .8 million now.

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or $4 million options. In this situation. because all future cash flows are certain. and tricky business endeavor. money.40 assuming that all future cash flows are known with certainty and that the interest rate is 6%. an intense work ethic. fun. the fact that Virginia lacks the start-up $4 million endowment shouldn’t deter her from achieving her entrepreneurial goal. she will also be profitable such that her current wealth works out to be $1.4 million which is approximately $4. risk-tolerance.4. Deviating from the $3 million investment option will not be profitable seeing as her current wealth remains highest by borrowing $3 million compared to the $1. Although she lacks the sizeable $4 million endowment that she had the pleasure of managing in questions two and three. the $3 million loan in this “perfect” capital market situation will be less than the present value of $4. If her business plan proves that it will be a profitable. $2.943. then it is time to take finance the operation. passion for the restaurant business. Not only will she be able to develop and operate her own restaurant. Even if the bank will only let her borrow against her future earnings. and realistic investment option. sometimes frustrating. Assuming that the “necessary skills” which Ginny possesses to operate the restaurant include perseverance.15 million. she should seriously consider embarking on this exhausting. . unique. self-confidence. and capital into the restaurant. my calculations in Table E demonstrate that Virginia will be able to achieve the target $3 million investment by using a bank loan as a financing option. Prior to consulting the bank regarding financing loans. and strong organizational skills.150. Virginia must formulate a comprehensive business plan to evaluate the profitability and feasibility of investing her time.

. savers view the $3 million investment option as optimal because it yields the highest future value of $5. savers. Despite the fact that Virginia now shares her ownership interests in the Virginia Corporation with a widely-diffuse group of investors. they prefer investments with higher future values. acceptable compromise can and should be reached by the both types of individuals. in this situation spenders view the $3 million investment option which yields the highest net present value of $5.150.4 million.5. some sides may argue for more or less money to be saved or spent on principle alone. this analysis demonstrates that a rational. the owners should not deviate from the optimal $3 million investment in the restaurant based on numerical evidence.943.4 million dollar future cash flow after year one plus the $1 million not invested paid out as a dividend to investors. they seek the optimal net present value and since savers favor future consumption. calculated by summing the $4. Since spenders have a high preference for current consumption. and spenders. Similarly.40 as their optimal choice. Although. Therefore.

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