My questions.
3. [5 pts] Why do we not use purchasing power parity theory in the short-run? Explain your reasoning.3. In Freedonia and Prisonia there are no taxes, and the capital markets are well-integrated across the two countries. Two multinational utility firms, FreeCorp and PriCorp, have woss that compete in the Prisonian market for electric power. Right now, the aggregate annual revenue of both producers is 1,050m/year, without any growth prospects. The current market value of FreeCorp's wholly owned subsidiary is 200m, while PriCorp's wos is worth 100m. Both companies are fully equity-financed. FreeCorp and PriCorp are negotiating a merger of their Prisonian subsidiaries. This would stop competition and would allow the producers to increase the price of electric power by 10 percent. Total sales would drop slightly, to 1,000m/year, but the higher profit margin would lead to a jv with a market value of 400m. (a) Assume initially that the newly formed I would be a fully equity- financed firm (no bonds, royalties, management fees, etc.). The mer- chant bank that acts as the adviser proposes that, as FreeCorp's assets are currently worth 200m and PriCorp's assets 100m, FreeCorp should get two-thirds of the shares.2. Suppose that company A's project has an NPV of 200 on its own, while com- pany B can realize 100. The synergy gain is 200. There are no taxes, and the financial markets are integrated. Assume, however, that B has a better bar- gaining position, and is able to obtain 45 percent of the equity in the first-pass negotiations (the pure-equity joint venture). (a) What part of the synergy gains goes to A, what part to B? (b) Suppose that, in the second-stage negotiations, A asks for a license con- tract worth 80 (in present-value terms). How should the equity shares be adjusted to preserve the division of the synergy gains (that is, to make both parties equally well-off as in the pure-equity solution)? (c) Which licensing contract is compatible with a 50/50 joint venture and the bargaining strengths used in part (a) of this question?4. [5 pts] The quantity theory of money can be written as M/P = L(O)Y. What is the function L(i)? Why is L() decreasing in ?The exercises below focus on the logic used in this chapter rather than on num- ber crunching. You should try to solve them without using any of the analytical solutions from the text. 1. Suppose that company A's project has an NIV of 200 on its own, while company B can realize 100. The synergy gain is 200. There are no taxes, the financial markets are integrated, and A and B have equal bargaining strengths. (a) How much of the total NPV (500) should go to A, and how much to B? (b) To achieve this, what should the equity holdings be in a pure-equity Iv? (c) Suppose that A and B agree that A will receive licensing fees from the IV worth 80 (in present value). i. How much of the total NPV (500) is left to be shared in proportion to the original cash inputs? ii. Write down the equal-gains principle, and solve for o. iii. Verify whether the synergy gains are shared equally. (d) Suppose, instead, that A and B agree on a 50/50 joint venture. What is the present value of the licensing income or management fees that A must receive in order to accept this equity structure
