Question
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
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, $24,000. Using his corporate finance training, he estimates that the free cash flow from the shop will be $6,000 per year, forever.
Investments with similar risk deliver a rate of return of 13%.
Part 1
What is the NPV of the project?
Part 2
In fact, the annual cash flow of $6,000 is an expected value: there is a 50% chance that annual cash flow will be $15,000 and a 50% chance that it will be -$3,000. 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?
Part 3
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?
Part 4
What is the value of the option to expand?
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