Question
(Real options and capital budgeting) You have come up with a great idea for a Tex-Mex-Thai fusion restaurant. After doing a financial analysis of this
(Real
options and capital
budgeting)
You have come up with a great idea for a Tex-Mex-Thai fusion restaurant. After doing a financial analysis of this venture, you estimate that the initial outlay will be $5.7
million. You also estimate that there is a 50 percent chance that this new restaurant will be well received and will produce annual cash flows of 800,000
per year forever (perpetuity), while there is a 50 percent chance of it producing a cash flow of only 180,000 per year forever (a perpetuity) if it isn't received well.
a. What is the NPV of the restaurant if the required rate of return you use to discount the project cash flows is 12 percent?
b. What are the real options that this analysis may be ignoring?
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a. Assume the required rate of return you use to discount the project cash flows is
12 %. What is the NPV of the restaurant if things go well?
c. Explain why the project may be worthwhile even though you have just estimated that its NPV is negative?
What is the NPV of the restaurant if things go poorly?
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