4. James is thinking of starting a restaurant. He has S200,000 to invest in his

Question

4. James is thinking of starting a restaurant. He has S200,000 to invest in his restaurant. He has two choices. Open a small restaurant without any other investors, i.e. he would own 100% of it or open a larger restaurant and own only 75% of the restaurant. The S200,000 to open the restaurant is all paid up front in year 0 If demand is good, James believes the small restaurant would generate profits of $25,000 in year 1, $40,000 in year 2, $65,000 in years 3 and 4 In year 5 he believes he can sell the restaurant for $300,000. Show the equation needed to calculate the Net Present Value of his investment in the small restaurant if demand is good. You do not need to calculate NPV, just set up the equation. Use an interest rate-12.0%. 3 pts. If demand is good the NPV of opening the restaurant in part a. is $112,011.63. If demand is lackluster the NPV of the restaurant will only be S30 ,000. If there is a 40% demand is good and a 60% demand is lackluster calculate the Expected Net Present Value of opening the small restaurant. 3 pts. If James decides to open the larger restaurant, he finds that if demand is good, the NPV of the profits is S180,000. If demand is lackluster, the NPV is only $30,000. Again, if there is a 40% chance demand is good and a 60% chance that demand is lackluster, calculate James, Expected Net Present Value (i.e. only the NPV of what James receives) of opening the large restaurant. 3 pts. a. b. c. d. Based on your answers in b. and c., which restaurant should James open? 3 pts.

Explanation / Answer

a. In excel you have use below given formula

=NPV(rate, value 1, value 2, value 3....) + investment

So for you rate is 12%, value 1 = 25000, value 2 = 40000, value 3 = 65000, value 4 = 65000 and value 5 = 300000, and your investment is $ 200000

So in excel you have to put

=NPV(12%,25000,40000,65000,65000,300000) + (-200000)

b. Expected NPV is

=(112011.63×0.4)+(30000×0.6)

=$ 62,804.652

c. If James open the larger restaurant then own only 75% of the restaurant.

Expected NPV = (180000×0.75×0.4)+(30000×0.75× 0.6) = $ 67,500

d. Based on b and c answers I would suggest that James should open larger restaurant as NPV is higher for larger restaurant compare to small restaurant.

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