CORPORATE FINANCE

Corporate Finance Coursework Assignment

Corporate Finance Coursework Assignment

Data

Risk free rate = i = 8%

B = 0.03

Total Reserves = 50,000,000 barrels

Uncle's interest = 1/3 of total reserves = 16,666,667 barrels

Development Cost = $12 per barrel

Time period = 20 years

Lag time required = 2 years

Total time = 22 years

Net production revenue per year = 5% x 50,000,000 x 12 =

Net production revenue per year = $ 30,000,000

Marginal revenue = $ 12/barrel

Net revenue in 20 years = 30,000,000 x 20 = 600,000,000

Uncle`s total interest = 1/3 x 600,000,000 = 200,000,000

Uncle`s interest per year = A = 200,000,000/20 = 10,000,000

Formula

Future Value = A * (1 + i) n - 1

i

Solution

Future Value = 10,000,000 x (1+0.08)20 - 1

0.08

Future Value = 10,000,000 x (1.08)20 - 1

0.08

Future Value = 10,000,000 x 4.661 - 1

0.08

Future Value = 10,000,000 x 3.661

0.08

Future Value = 10,000,000 x 45.7625

Future Value = $ 457,625,000

Result

For this investment opportunity the total value of uncle`s interest is $ 457,625,000. This value is based on future annuities and the interest rate is considered at 8% per annum. Other factors like inflation and price of oil also remains constant.

Investment opportunity

Investment opportunities play an important role in corporate finance. The mix of assets-in place and investment opportunities affects a firm's capital structure, the maturity and covenant structure of its debt contracts, a firm's dividend policy, its compensation contracts, and its accounting policies. Not surprisingly, measures of a firm's investment opportunity set feature prominently in the empirical corporate finance literature. Since investment opportunities are typically unobservable by outsiders, a common practice is to rely on proxy variables to measure a firm's investment opportunity set.

However, little is known about how well these proxy variables perform. Existing studies that evaluate the performance of proxy variables are rare, reflecting the problem that investment opportunities are typically unobservable. Kallapur and Trombley (1999) measure investment opportunities by the realized growth in firms' book values of equity, assets, and sales, but report only rank correlations between these measures and various proxies for the investment opportunity set. Goyal, Lehn, and Racic (2002) examine how investment opportunity proxies change when there is an exogenous shock to the investment opportunity set. They argue that investment opportunities in the U.S. defense industry increased substantially during the Reagan administration of the early 1980s, but declined significantly with the end of the cold war and the resulting large cuts in the defense budget in the late 1980s.

Their empirical results show that the proxy variables mimic the rise and fall in the industry's investment opportunities. Erickson and Whited (2001) examine the magnitude of the measurement error in several proxy variables for Tobin's q. They find that although some methods of constructing proxies are better than others, all of the proxies still contain significant measurement error. Little is known, however, about the relative information content of the various proxies of a firm's investment opportunity set. Given that empirical researchers must rely on imperfect proxy variables, it is valuable to know which one among these imperfect proxies performs ...