Ginny's Restaurant:

Virginia will receive $2 million today and $3 million one year from today.Virginia does not have any other assets.There are no transaction costs or taxes, and all potential creditors and investors have all relevant information about investment payoffs.All these assumptions together are sometimes summarized by saying the capital marketsare"perfect."In addition, assume that allfuturecashflows are known with certainty.For simplicity, assume that Virginia lives in a world that lasts onlyone year, and the rate of interest is 6 percent.

1.What is Virginia's current wealth (equivalently, what is the present value of her assets)?How much money can she spend and consume today?How much of the money can she spend and consume one year from today if she consumes nothing today?

Suppose thatinsteadofhavingatwo-periodendowment,Virginiahasaninitialendowmentof$4million.She decides toinvestpartofthe$4millioninGinny'sRestaurant whichshewillbuildand manage.

Thedatabelowindicatesthefuturecashflows(endoftheyear)thatwillresultfroman investment today.All payoffs are completely certain and known to all.

Investment (today)Future Cash Flow (end of year)

1.0 million1.8 million

2.03.3

3.04.4

4.05.4

2.Howmuchofthe$4millionshouldVirginiainvestintherestaurant?WhathappenstoVirginia's wealth when she makes the investment in Ginny's Restaurant?

3.TheVirginiaCorporationnowconsistsofcash(remainingaftertheinvestmentinGinny's) andGinny'sRestaurant.AssumethatVirginiaiscontemplatinganotherinvestment,namely tosellsmokedhamsviatheinternet.Thisprojectwillrequirea$2.5millioninvestmentand will yield a future cash flow of $3.4 million.Should she undertake this investment?Assumethat she does not want to use internal cash to finance the investment, nor does she want to usedebt financing.There are currently 200,000 shares outstanding in the Virginia Corporation.