Question
You are planning to open a restaurant. The building, inventory, etc. will cost you $300,000 up front. If the restaurant is extremely successful, you expect
You are planning to open a restaurant. The building, inventory, etc. will cost you $300,000 up front. If the restaurant is extremely successful, you expect free cash flows of $100,000 per year indefinitely, with the first cash flow occurring at year 1. If the restaurant is moderately successful, you expect free cash flows of $50,000 per year indefinitely. If the restaurant is unsuccessful, you expect free cash flows of negative $80,000 annually. You will know how successful the restaurant will be after one year. If it is extremely successful, you will open a second location. This will cost you $300,000 in year one and will create a second perpetuity of $100,000, beginning in year two. If the restaurant is unsuccessful, you will close the restaurant after year one at no cost or benefit. There is a 25% chance that the restaurant will be extremely successful, a 50% chance it will be moderately successful, and a 25% chance it will be unsuccessful. With a discount rate of 15%, what is the NPV of the restaurant when including both the real option to expand and the real option to abandon?
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