1.To start up a business you, as its founders, must invest as follows:

Year

0

1

2

3

4

Investment

$4,000,000

$2,000,000

$1,000,000

$500,000

$250,000

Following the times when you are investing, the business is projected to make positive cash flows. For year 5, the cash inflow is expected to be $150,000 and this is expected to double each year ending with the cash flow that occurs at year 10. In year 11 and into the future, the cash flows are expected to grow at a rate of 3% per year (and continuing in perpetuity).

a)If the risk of the business implies an appropriate discount rate of 16% per year, what is the economic profit generated by this business venture (i.e., what is the NPV of starting this business)?

b)What is the present value of the investment in the business (just the investing cash flows - the cash flows from year 0 to year 4)? Show how this can be calculated with the PV growing annuity equation using the year 0 cash flow as the first cash flow of the growing annuity (show the equation with the numbers in it - use Word's equation editor in a professional manner with the appropriate numbers in it so that it captures, within the growing annuity, all five of the cash flows from years 0 to 4 inclusive).

c)Suppose the owners of the business do a public offering of the business on the stock market at the end of year 4 (just after the last investment cash flow) and the market has the same expectations of future cash flows (as stated above for years 5 onward).

i)What will be the market price of the business when it goes public (at year 4)?

ii)What would be the present value of this amount discounted back to year 0?

iii)What does this imply about the economic profit expected to be received by the people who buy the stock in the public offering?

iv)What does this imply about the economic profit expected to be received by the original founders of the business? In answering this, use the result from parts c.i, c.ii, and b. Compare this result to your answer in part a.

d)What is the IRR of this business? Hint, you may want to set up the first 10 years of cash flows on a spreadsheet and then bring in the growing perpetuity formula to handle the cash flows from year 11 onward. Make sure all discounting references one rate cell. Then you can use Solver to determine the IRR by solving for NPV = 0 by changing the number in the rate cell. (Please use a clear high-resolution screen capture printout to show the setup of Solver and the result following running Solver.)