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Solution to Management Science Series #193: Valuing Patents/Licenses by Using Options

Toy company called Shippuden made a license agreement with the video games company called ‘SUGA’. The license would allow Shippuden to produce the toys including figures and playsets of the IP owned by SUGA for the next 10 years. Shippuden will produce and market the toys.

Financial analysts of Shippuden completed the DCF analysis and it was estimated that future cash flows for this licensing project would amount to $6.7 billion. It is also estimated that current cost of developing the products and starting production would be around $7.2 billion.

This is a new project for Shippuden and it has not been involved in such projects before. So, its analysts adjusted the risk of the project accordingly and the standard deviation of returns on such projects is estimated conservatively at 53%.

Should Shippuden collaborate with SUGA immediately on this licensing project?

How valuable will this project be if Shippuden has the option to delay the development and the production?

What would have been the right action for Shippuden if the development and production of the toy had cost $6 billion instead of $7.2 billion originally? Should Shippuden develop and start production in this case?

Solution to Management Science Series #192: Accounting for Investments in Other Companies and Financial Forensics 🕵️

A publicly traded company, Museum Enterprises (ME) has had rough years lately not living up to the expectations of financial markets and equity investors, missing all of its target earnings.

ME, which stores and sells art collectibles, believes that organic growth is not viable given the current market conditions.

So, at the end of the last fiscal year, it purchased 65% of equity in Castle Entertainment. At the end of this fiscal year, Castle recorded $500M in revenues and incurred total expenses amounting to $230M.

-How will this investment affect ME’s revenues and operating income? Give a quantitatively concrete answer.

-How will this investment help ME’s income before income taxes? Give a quantitatively concrete answer.

-Assume that ME has 40 million shares of stock issued and outstanding and the corporate tax rate for ME is 21%. How will ME’s investment in Castle affect its EPS this year; calculate it!

On education and financial literacy and how financial literacy taught early can impact our world for the better

Remember what I posted on the 7th of February, 2022:
https://bit.ly/3NC9y1f
On the 22nd of March, 2022, it is required for high school students in Florida to take a financial literacy course before graduation.
Financial literacy has always been important and many people, especially young people, has not had the tools to develop their understanding towards finance and investment management.
This knowledge is required.
Countries educating their youth on finance and investment will be more likely to reap the rewards in the future as the youth will be able to make sound financial decisions without squandering their time, money, as well as their country’s wealth.
In this article, I try to idealize a world in which financial literacy is prevalent, elaborating on what could be done to increase financial literacy and how it could change the financial decisions of current and next generations while also providing some snippets and true stories from my own life. I also briefly investigate how financially literate generations will impact the world we live in macroeconomically.

Solution to Management Science Series #191: Binomial Model at Its Finest: Okami Games Example 🎮

Okami Games is a prominent video game developer and publisher financed by both debt and equity. Okami is planning to undertake a new AAA-level game.

If this game garners critical acclaim, the value of Okami in a year will be $560M. If the game fails miserably, Okami’s value will be $430M. Current enterprise value of Okami is $495M, which takes the prospect of the new game into consideration.

Okami has outstanding zero coupon bonds due in a year with a face value of $520M. The yield on a 1-year US Treasury Bill is 4% EAR. Okami does not pay any dividends.

-First, use the binomial model to calculate the current value of Okami’s debt and equity.
-If Okami has 400,000 shares of common stock outstanding, what is the price per share of Okami’s equity?

Okami has also another option to develop a brand-new triple-A game of the survival horror genre. This new game is expected to either increase the value of Okami to $600M or decrease Okami’s value to $400M by the end of the year.

Okami believes that the value of the firm today will remain at $495M even if this new project replaces the preceding one.

-First, use the binomial model to calculate the current value of Okami’s debt and equity if Okami chooses this new project over the preceding one. Calculate the price per share of Okami’s equity accordingly.

-Without calculating any values, could you make a definite claim on which project would benefit the shareholders and the bondholders? Subsequently, corroborate your claim with the algebraic solution.

Securing the longevity of companies

If only you had known these before investing in a tech venture (or any private company)
Some well-known secrets 😉
#2
It is hard to assess how long a company will live.
Of course, any founder will want his/her company to live as long as possible but as is the case with people, companies cease to exist, too.
Sometimes, they evolve, holding a little longer and defying their fate.
However, for many tech ventures, the lifespan is short although they live by dog years.
How long was the average lifespan of a tech venture born in the original dot-com era after the venture had gone public?
It was 3 years.
In this article, I’ve focused on some of the factors affecting the longevity of companies, providing some real-world examples of successful and unsuccessful ones.

Solution to Management Science Series #190: Real-world application of the binomial model: Milk Example 🧮

Real-world application of the binomial model

You have built a trading company called ‘Gold Milk’. The company buys milk from farmers at the wholesale price and resells it to the diary companies and restaurant chains at a higher retail price.

Gold Milk generates its revenues mostly during the spring period. Today is December 1st and milk sells for $2.40 per gallon. Based on your models, milk prices will be either $3.50 or $1.35 per gallon on March 1.

You do not know the probabilities of each state occurring. The three-month risk-free rate for borrowing and lending is 1.5%. Gold Milk has the ability to pass the price changes onto its customers and adjusts prices accordingly in March.

Diary King is a diary company and wants to buy milk from you. The company plans to buy 2 million gallons of milk from Gold Milk at $2.50 per gallon on March 1st. Diary King says that it can pay you $1,500,000 up front on December 1st for this contract in order to mitigate your risk.

Should Gold Milk sign the contract with Diary King?

What to (and not to) make of Startups: Introducing additional well-known secrets of venture capital and start-ups

On the 9th of March, 2022 I shared a post on some well-known secrets within the venture capital:
https://bit.ly/3wEc80F
On the 15th of March, 2022, Bloomberg LP published the following:
Homebuying Startup Knock Scraps Plans to Go Public, Lays Off Half Its Staff
· Housing-tech firm instead raises $70 million in private round
· CEO says collapse of Zillow iBuying business spooked investors
“The business is doing great, but we built to be a public company, and there’s no IPO market right now,” Black said. “It does feel like money has gotten very scarce and very expensive.”
Link to the article: https://bloom.bg/3qG0D4O
**
Is your start-up ready for the many challenges ahead?
How can you make your start-up more resilient against unexpected circumstances?
Analysts, VCs, underwriters, or even your finance department, may assess a value for your company. Is it reliable?
I will try to answer these questions in this article. Also, we will take a quick look at what happened to Knock.

Solution to Management Science Series #189: Using Binomial Option Pricing Model to Value a Put 🧮

As an options trader at the CBOE, you are tasked with pricing a European put option on Quake Games, Inc.

The strike price is $75 and there are 6 months until expiration. Quake Games’ common stock does not pay dividends and is currently trading at $57.

Based on your models, the future stock price is predicted to be either $92 or $40 at the end of the next 6-month period. The effective annual risk-free rate is 4%. Estimate the price of the put?

How much of a share of the stock do you need to buy or short and how much do you need borrow or lend at the risk-free rate to replicate the put through a synthetic portfolio?

Check whether your synthetic portfolio replicating the put will have the same payoffs as those of the put at expiration!

Financial Accounting is a forensic tool! This time, the focus is accounting for receivables! Detecting frauds ranging from channel stuffing and bill and hold to roundtripping

Ability to use financial accounting at expert level gives the user a forensic tool.
Accounting frauds and schemes will become easier to detect, solve, and track when one masters it.
Innumerable scandals in the business world have been related to accounting frauds and they are still happening (why it is so is a long debate)
For example, think of a retailer having a hard time to hit its fourth quarter sales target. The trend shows that it will not hit the target by quarter end. However, by a sleight of hand, it magically hit the revenue target.
Where would you look at first? Which accounts and ratios would lead you to the detection of these inflated revenue numbers?
While answering all of these questions, I will also provide you with some recent examples of accounting scandals and how you could have detected them in the first place. I will also present you with some additional resources concerning the topic.

Solution to Management Science Series #188: Using Binomial Option Pricing Model to Value a Call 🧮

Using Binomial Option Pricing Model to Value a Call 🧮

As an options trader at the CBOE, you are tasked with pricing a European call option on Quake Games, Inc. The strike price is $75 and there are 6 months until expiration.

Quake Games’ common stock does not pay dividends and is currently trading at $57.

Based on your models, the future stock price is predicted to be either $92 or $40 at the end of the next 6-month period.

The effective annual risk-free rate is 4%. Estimate the price of the call?

How much of a share of the stock do you need to buy and how much do you need borrow at the risk-free rate to replicate the call through a synthetic portfolio?

Check whether your synthetic portfolio replicating the call will have the same payoffs as those of the call at expiration!