Question 1. (50 marks] Outdoor LTD produces mountain bikes. The business generates annual revenues of 50m and operating costs of 20m. In the absence of changes to the product, these numbers are expected to be stable over time. The company is however considering introducing an innovative braking system on its bikes. This will require an initial investment of 10m to change the production line and is expected to increase both revenues and costs by 10%. For this to happen, however, the company needs to purchase a license from the new system's patent holder. The company is currently negotiating a 5 year license (assume that the license is not expected to be renewed at the end of the period and the company is expected to revert to the old system). For simplicity, assume that there are no taxes, that the licensing fee and the initial investment are payable as a lump sum at the beginning of year 1 and that all other revenues and costs occur at the end of the year. a. Given a 10% discount rate, what is the maximum fee that Outdoor LTD should pay for the license? b. Different from a., suppose that: Outdoor LTD has an estimated beta equal to 2, the risk free rate is 2%, the market risk premium is 5%, the yield to maturity of the company's bonds is 6% and that the company has a debt to equity ratio equal to one. Calculate the company's cost of capital and determine the maximum fee. C. Different from a., suppose that Outdoor LTD is not listed on an exchange, so that the data on stock returns needed to estimate its beta are not available. How would you proceed in this case? Question 1. (50 marks] Outdoor LTD produces mountain bikes. The business generates annual revenues of 50m and operating costs of 20m. In the absence of changes to the product, these numbers are expected to be stable over time. The company is however considering introducing an innovative braking system on its bikes. This will require an initial investment of 10m to change the production line and is expected to increase both revenues and costs by 10%. For this to happen, however, the company needs to purchase a license from the new system's patent holder. The company is currently negotiating a 5 year license (assume that the license is not expected to be renewed at the end of the period and the company is expected to revert to the old system). For simplicity, assume that there are no taxes, that the licensing fee and the initial investment are payable as a lump sum at the beginning of year 1 and that all other revenues and costs occur at the end of the year. a. Given a 10% discount rate, what is the maximum fee that Outdoor LTD should pay for the license? b. Different from a., suppose that: Outdoor LTD has an estimated beta equal to 2, the risk free rate is 2%, the market risk premium is 5%, the yield to maturity of the company's bonds is 6% and that the company has a debt to equity ratio equal to one. Calculate the company's cost of capital and determine the maximum fee. C. Different from a., suppose that Outdoor LTD is not listed on an exchange, so that the data on stock returns needed to estimate its beta are not available. How would you proceed in this case
