Questiom: You are preparing a project evaluation for a new retail store, E-bay Store[1]. You do not intend to OWN the retail store, but instead, you are negotiating a lease for the retail location.

The following data relates to this new store project:

• Initial investment, $400K this will pay for the leasehold improvements,[2] signage, technology, fixtures and fittings. This will be spent at t = 0.
• Based on prior experience of these type of operations, the store will either be Good, Average, or Poor. We can estimate the after-tax cash flows and likelihood of each outcome as follows:

Type	Likelihood	Annual A-T FCF
Good	30%	$200K
Average	50%	$150K
Poor	20%	-$100K

To understand this table, the following will illustrate: If we open the store, there is a 30% chance of it being a good location, and if that is the case, annual after-tax cash flows will be $250K. Unfortunately, even though we will prepare detailed analysis of the potential location, discovering the actual quality of the location will not be known until after one year of the operation.

• The lease will be for five years.
• The cost of capital for this project is 12%.

1. Given this data, should we open the store? (Hint, simple annuity structure!)
2. Suppose we wish to negotiate a break out clause in the lease after 1 year. This will allow us to break the lease at the end of one year should we wish to. How much should we be willing to pay for this break-up clause? Why? (Ignore taxes)
3. Continuing from part b). IF the landlord in fact wants the following clause: At the end of the first year of the lease, the tenant may break the lease by paying the landlord $100K on that date in one year. What is this option worth? [Hint: You know the present value if no break out is the answer from a). What is the present value WITH this clause? The value of the option is the difference between these amounts. Since Option Value = PV of CF WITH option - PV of CF WITHOUT option.)