The owner of the Krusty Krab is considering selling his restaurant and retiring.

Question

The owner of the Krusty Krab is considering selling his restaurant and retiring. An investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready for retirement. The owner is considering the following:

1. Sell the restaurant now and retire.

2. Hire someone to manage the restaurant for the next year and retire. This will require the owner to spend $50,000 now, but will generate $100,000 in profit next year. In one year the owner will sell the restaurant.

3. Scale back on the restaurant's hours and ease into retirement over the next year. This will require the owner to spend $40,000 on expenses now, but will generate $75,000 in profit at the end of the year. In one year the owner will sell the restaurant.

If the interest rate is 7%, the alternative with the highest NPV is:

A) Alt. #2 with an NPV of approx. $380,561

B) Alt. #3 with an NPV of approx. $357,196

C) Alt. #2 with an NPV of approx. $370,561

D) Alt. #1 with an NPV of approx. $350,000

Explanation / Answer

Net present value = Present value of cash inflows-Present value of cash outflows

Alt 2:

= ($350,000+$100,000)÷1.07-$50,000

= $370,561

Alt 3:

= ($350,000+$75,000)÷1.07-$40,000

= $357,196

Alternative 2 has highest NPV, Select (C)

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