EC334 Assessment 2022
Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: daixieit
2022 EC334 Assessment
Please do either questions 1-3 or question 4
1. An automotive company is considering whether to introduce a new kind of electric vehicle (EV) battery. A ‘gigafactory’ facility to produce these batteries can be built this year (2022) at a cost of £1,500,000. Potential sales are estimated by the inverse demand curve 
= 
− 
, where Q is the quantity sold and P is the price. At the same time, the Government is considering legislation to establish a minimum standard for EV batteries. If the legislation passes, the Intercept of the demand curve will rise by 50%; if the legislation is abandoned, the intercept will fall by 25%. The plant will start producing in 2023 if the investment is made; the (constant) marginal cost will be £2000; if the law is passed, the cost will fall to £200 (thanks to government subsidies to producing batteries compliant with the law). The risk free interest rate is 10%. Assume that the law has a 25% chance of being enacted and that all price risk is diversifiable. The plant, once built, will operate forever.
a. Should the firm build the plant now?
Now suppose that the firm can now (in 2022) acquire an option to conduct R&D on a cheaper way to make batteries. If they exercise the option, the firm will have to spend an additional £100,000 on R&D and the production cost will fall by 40%, with effect from 2024.
b. How much would the firm be willing to pay for this option?
Suppose that the firm can also opt to delay building the plant by one year. In other words, the firm can purchase in 2022 an option to delay building the plant (for the same cost of £1,500,000, payable in 2023) until after it is known whether the law has passed.
c. Assuming the firm did not have the option to do R&D, how much would it be willing to pay for the option to delay?
d. How much would the firm be willing to pay for a package consisting of both options? (If the firm decides in 2022 to purchase both options, it can choose in 2023 whether to invest nothing, £1,500,000 for the plant or £1,500,000 for the plant + £100,000 for the R&D; if it delays building the plant, production will start in 2023)
e. Finally, suppose the firm could lobby to ensure that the law is enacted. If it does so, there is no point in the other options, since there would be no uncertainty about the outcome (the law would be in force). Assuming that the firm could still choose whether or not to invest in R&D in 2023 if and only if it had invested in building the plant in 2022, how much would it be willing to pay to guarantee that the law was enacted?
2. Imagine that at some future date, a company (Maskerade) will start a new venture making PPE. As of that date, the company will have 150,000 shares outstanding. Earnings will be £1,200,000 at the end of year 1 and £2,000,000 at the end of year 2. An investment outlay of £500,000 at the end of year 1 has already been committed. The company is all-equity financed with a required rate of return of 12% and will be liquidated after 2 years. Assume that the firm operates in a world with perfect capital markets. The firm’s policy is to pay out any surplus cash as dividends.
a. What is the current (year 1) share price of the company’s stock?
b. PrivateVentures Ltd. owns 15% of the company and wants an income from the firm of £50,000 at the end of year 1. Show how they can achieve this (without a change in
the firm’s dividend policy). What percentage of the firm will they own after the end of year 1 following this strategy?
c. How can PrivateVentures obtain the same income as in part b by changing the current dividend policy of Maskerade? How many shares will Maskerade have outstanding at the end of year 1 under the new policy? What percentage of the firm will PrivateVentures own at that time?
3. A private investor (PIR) is interested in taking over the Warwick Parkway to London Marylebone rail line. The revenues of operating the plant are determined by the passenger demand - a random parameter 
distributed uniformly on [0, 1] - and by the electricity (
) used; the electricity is provided by a Cornish supplier (EDC). The revenue function is 
, the cost of electricity supply is 
and the supplier’s outside option is 
> 
. PIR needs to specify a contract paying EDC an amount 
(if the railway produces revenue 
, PIR gets 
− 
and the electricity supplier EDC gets 
. Suppose, moreover, that EDC must accept or reject the contract before observing 
, but chooses the amount of electricity after observing it.
a. First assume that PIR can observe the revenue R but cannot separately observe 
or 
. You may assume that the contract takes the form 
= 
where 
is a (not necessarily positive) parameter. Find EDC’s optimal quantity as a function of 
, 
and R, and use this to compute the value of 
that maximises the PIR‘s expected profit. Also, find the optimised expected value of the railway line as a function of 
.
b. How (if at all) would your answer differ if EDC observed 
before accepting or rejecting the contract? (you should set up the problem, but do not have to solve it explicitly).
c. Now suppose that the investor can choose a contract that depends on 
(
= 
) or on d (
= 
) but not both. In other words, they must pay off the fuel supplier before observing the value of revenue R. As before, the fuel supplier accepts or rejects the offer before observing 
. Which would the investor prefer to observe?
4. Short essay (3000 words max) “All firms offering computer-based trading services should be required to charge fees that are proportional to the earnings of their investor’s portfolios.” Discuss why the contracts between specialist computer-based trading firms should be regulated and provide a reasoned argument as to whether you agree or disagree with this statement.
2022-04-08