seem4480hw2sol.pdf - SEEM4480 Decision Methodology and...

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SEEM4480 Decision Methodology and Applicatons Xuedong He, Spring 2020 Suggested Solution to Homework 2 Assignment 1. As of August 14, 1969, the asset of Waterman Engineering Corporation (WEC) consisted of $57,000 cash and $90 , 000 $57 , 000 = $33 , 000 illiquid assets (i.e., the construction and offce equipment). The WEC’s after-tax profit, as of Au- gust 14, 1969, for the fiscal year May 1, 1969 to April 30, 1970 was $89,000, of which $40,000 had been used to repay the Waterman family’s loan, so the remaining amount is $89 , 000 $40 , 000 = $49 , 000 . This amount is already counted in the amount of cash reserved by WEC as of August 14, 1969. Thus, without taking the Norwood or the Prescott deal, WEC’s net liquid assets on April 1, 1970 amounts to $57 , 000 . In the following, we analyze the after-tax profits in the Norwood and in the Prescott deals, so we are able to compute WEC’s net liquid assets on April 1, 1970 given WEC’s action and the realization of outcomes. We first analyze the consequences of the Norwood deal. If WEC takes this deal, the total cost of building the community television antenna and transmitting signals using a microwave link is $110,000 and the total cost of building the antenna and transmitting signals using coaxial cable is $180,000. Whichever transmitting type used, WEC needs to build the community television before the examiner’s report comes out, and the cost in this stage is $80,000. Thus, after the examiner’s report is released, the remaining cost to complete the sys- tem is $30,000 if WEC chooses to transmit signals using a microwave link and is $100,000 if WEC chooses to transmit signals using coaxial cable. The uncertainty in the Norwood deal arises from the examiner’s report, which can yield three consequences: granted of an unrestricted license, granted of a restricted license, and refused. After seeing the examiner’s report, WEC can decide whether the continue to build the system and whether to transmit sig- nals using a microwave link or coaxial cable. The Norwood syndicate is willing to pay $150,000 for the system with signal transmitting and an unrestricted li- cense or with coaxial cable. The syndicate is also willing to pay $120,000 for the system with microwave transmitting and an unrestricted license or with coax- ial cable transmitting. Of course, the system is worthless if it uses microwave transmitting without any license. Because the remaining cost of building the system with microwave transmitting is $30,000 and the remaining cost of build- ing the system with coaxial cable transmitting $100,000, WEC will make the following decision after seeing the examiner’s report: If WEC is granted with an unrestricted license, WEC will choose to complete the system with microwave transmitting. In this case, the before-tax profit is $150 , 000 ($80 , 000 + $30 , 000) = $40 , 000 . 1
SEEM4480 Decision Methodology and Applicatons Xuedong He, Spring 2020 Recall that the tax rate is 48%, so the after-tax profit in this case is $40 , 000 × (1 48%) = $20 , 800 . If WEC is granted with a restricted license, WEC will choose to complete the system with microwave transmitting. In this case, the before-tax profit is $120 , 000 ($80 , 000 + $30 , 000) = $10 , 000

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