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, $52,000. Using his corporate finance training, he estimates that the free cash flow from the shop will be $13,000 per year, forever.

Investments with similar risk deliver a rate of return of 12%.

Part 1

What is the NPV of the project?

Correct

13,0000.12

Part 2

In fact, the annual cash flow of $13,000 is an expected value: there is a 50% chance that annual cash flow will be $32,500 and a 50% chance that it will be -$6,500. 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?

Part 3

Fortunately, Joe's rich relatives are willing to provide him with enough capital to open another 2 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?