July 26: Resource redeployment

Arkadiy Sakhartov, Associate Professor of Business Administration, Gies College of Business, University of Illinois at Urbana-Champaign

Link for synchronous sessions: https://hbs.zoom.us/j/97071216335?pwd=MUZRMFB0L2xXUDRxdU9nSHVMNWtYQT09

Meeting ID: 970 7121 6335

Password: tom

Practice Problem

Resource relatedness, redeployability and firm value (Arkadiy Sakhartov)

(Accompanying Excel spreadsheet here)

Consider a firm that enters the model having been previously focused on industry i : the firm operated a unit of resources in industry i. In the remaining three periods of the resources’ useful life, that unit can be used in two industries, i and j. In the first period, the use of all resources in industry i would generate certain net cash flow Ci =10; whereas the use of all resources in industry j would generate certain net cash flow Cj =10. In the second and the third periods, the net cash flow for a unit of resources is uncertain in industry j: it follows the binomial process specified in the Excel spreadsheet; whereas the net cash flow for the unit of resources deployed in industry i is certain and grows with the risk-free interest rate r = 0.1, also as shown in the Excel spreadsheet.

In each of the three periods, the firm can use redeployability of its resources: it can withdraw the whole unit or a half of a unit of resources from one industry and redeploy them to another industry. If the firm uses only a half of resources in an industry, the cash flow generated in that industry is also halved. Resource redeployment is costly with total costs determined by: (a) the dissimilarity (unrelatedness) of resource requirements between i and j that is operationalized as S =1, and (b) the amount of redeployed resources. In particular, if all (or a half of) resources are redeployed to i or to j, the firm pays the redeployment cost equal S (or 0.5S).

Compute: (a) the expected discounted net present value VR of the firm when redeployability is present; (b) the expected discounted net present value V of the firm when redeployability is absent; and (c) the expected discounted net present value of resource redeployability R.