Intro Joe Avery recently graduated from college and has an idea for a juice shop using only organic and locally- sourced ingredients. He has saved just enough money to cover the initial investment required to open the shop, $60,000. Using his corporate finance training, he estimates that the free cash flow from the shop will be $15,000 per year, forever. Investments with similar risk deliver a rate of return of 12%. Attempt 1/3 for 10 pts. Part 1 What is the NPV of the project? 37333 Correct Since the annual cash flows are constant and occur forever, we can use the perpetuity formula to find their present value: NPV 60,000 + 15,000 0.12 65,000 Part 2 Attempt 2/3 for 9 pts. In fact, the annual cash flow of $15,000 is an expected value: there is a 50% chance that annual cash flow will be $37,500 and a 50% chance that it will be -$7,500. Because of a very restrictive leasing contract, he cannot close down the shop even if there is no demand. What is the expected NPV of the project? 37333 Correct Without the option to expand, the NPV in each case is as follows: Best case: NPV 37,500 60,000 + 0.12 - = 252,500 Worst case: NPVW = 60,000 + 7,500 0.12 122,500 Expected NPV: E(NPV) = 50 % 252,500 + 50 % ( 122,500) 65,000 The NPV is unchanged. Part 3 Attempt 3/3 for 8 pts. Fortunately, Joe's rich relatives are willing to provide him with enough capital to open another 4 shops after the first year if there is a lot of demand. What is the true NPV of the project? 0+ decimals Submit Attempt 2/3 for 7 pts. Part 4 What is the value of the option to expand? 0+ decimals Submit Intro Joe Avery recently graduated from college and has an idea for a juice shop using only organic and locally- sourced ingredients. He has saved just enough money to cover the initial investment required to open the shop, $60,000. Using his corporate finance training, he estimates that the free cash flow from the shop will be $15,000 per year, forever. Investments with similar risk deliver a rate of return of 12%. Attempt 1/3 for 10 pts. Part 1 What is the NPV of the project? 37333 Correct Since the annual cash flows are constant and occur forever, we can use the perpetuity formula to find their present value: NPV 60,000 + 15,000 0.12 65,000 Part 2 Attempt 2/3 for 9 pts. In fact, the annual cash flow of $15,000 is an expected value: there is a 50% chance that annual cash flow will be $37,500 and a 50% chance that it will be -$7,500. Because of a very restrictive leasing contract, he cannot close down the shop even if there is no demand. What is the expected NPV of the project? 37333 Correct Without the option to expand, the NPV in each case is as follows: Best case: NPV 37,500 60,000 + 0.12 - = 252,500 Worst case: NPVW = 60,000 + 7,500 0.12 122,500 Expected NPV: E(NPV) = 50 % 252,500 + 50 % ( 122,500) 65,000 The NPV is unchanged. Part 3 Attempt 3/3 for 8 pts. Fortunately, Joe's rich relatives are willing to provide him with enough capital to open another 4 shops after the first year if there is a lot of demand. What is the true NPV of the project? 0+ decimals Submit Attempt 2/3 for 7 pts. Part 4 What is the value of the option to expand? 0+ decimals Submit
