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CH03 - Chapter 3 The Valuation Principle The Foundation of...

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Chapter 3 The Valuation Principle: The Foundation of Financial Decision Making Note: A box ( ) indicates problems available in MyFinanceLab. An asterisk (*) indicates problems with a higher level of difficulty. 1. Plan: The benefit of the rebate is that Honda will sell more vehicles and earn a profit on each additional vehicle sold: Benefit = Profit of $6000 per vehicle × 15,000 additional vehicles sold = $90 million. Execute: The cost of the rebate is that Honda will make less on the vehicles it would have sold: Cost = Loss of $2000 per vehicle × 40,000 vehicles that would have sold without rebate = $80 million. Evaluate: Thus, Benefit Cost = $90 million $80 million = $10 million, and offering the rebate looks attractive. (Alternatively, we could view it in terms of total, rather than incremental, profits. The benefit as $6000/vehicle × 55,000 sold = $330 million, and the cost is $8000/vehicle × 40,000 sold = $320 million.) 2. Plan: If the shrimp from your Czech and Thai suppliers are of equal quality, you will buy the shrimp from the supplier who offers you the lowest price. One problem is the Czech supplier quotes you a price in koruna and the Thai supplier quotes you a price in baht. Since you will have to convert dollars to either koruna or baht, you will buy the shrimp from the supplier who will charge you the lowest cost in dollars. Execute: Czech buyer’s offer in dollars = 2,000,000 CZK/(25.50 CZK/USD) = 78,431.37 USD Thai supplier’s offer in dollars = 3,000,000 THB/(41.25 THB/USD) = 72,727.27 USD Evaluate: You would buy the shrimp from the Thai supplier because the Thai shrimp are ($78,431 $72,727)$5704 less expensive today.
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12 Berk/DeMarzo/Harford • Fundamentals of Corporate Finance 3. Plan: There are two related, but different, decisions to analyze. In both cases you will take that choice which will give you the highest value. Execute: a. Value of the stock bonus today = 100 × $63 = $6300 Value of the cash bonus today = $5000 Since you can sell the stock for $6300 in cash today, its value is $6300 which is better than the cash bonus of $5000 today. Take the stock. b. Because you could buy the stock today for $6300 if you wanted to, the value of the stock bonus cannot be more than $6300. But if you are not allowed to sell the company’s stock for the next year, its value to you could be less than $6300. Its value will depend on what you expect the stock to be worth in one year, as well as how you feel about the risk involved. There is not a clear cut answer to which alternative is best, because taking the stock today and have to hold it for a year involves risk. You might decide that it is better to take the $5000 in cash then wait for the uncertain value of the stock in one year. This would be
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