(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 nitial outlay will be $6 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 $780,000 per year forever (a 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 11 percent? b. What are the real options that this analysis may be ignoring? c. Explain why the project may be worthwhile even though you have just estimated that its NPV is negative?

(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 nitial outlay will be $6 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 $780,000 per year forever (a 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 11 percent? b. What are the real options that this analysis may be ignoring? c. Explain why the project may be worthwhile even though you have just estimated that its NPV is negative?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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You are considering a risk-free investment that costs $4000 and pays $5000 in one year. You can either pay all cash for the investment or you can borrow part and pay cash for the other part. If you borrow $2000, you will be required to pay back $2080 in one year. The risk-free rate is 4%. What is the project’s NPV? Is the NPV affected if you borrow some of the funds?
You are interested in investing in an office building. You expect the building's net operating income will grow at a constant rate of 4.5% per year during your anticipated holding period. If you are confident that you can earn 10.7% annual return somewhere else on projects of comparable risk, the reasonable cap rate for you to use in evaluating this building should be %? Write your answer without %. E.g. if you answer is 21.5%, just write 21.5
You have a potential project for which you want to establish the value of any possible real options. The project will have an initial cost of $86 million, which must be paid at the time of investment. You realize that the project has four possible cash flows starting in year 1 and continuing forever. First, there is a 22% chance of earning $1.02 million per year starting in year 1. Second, there is a 26% chance of earning $6.54 million per year starting in year 1. Third, there is a 20% chance the the project will earn $5.82 million per year. Fourth, there is a chance that the project will earn $3.22. These are the only four possibilities. In 2 year(s), you will be able to improve the quality of your manufacturing process to increase the net CFs from the project if you would like to. The cost of this will be $62 million, and the cash flows will increase beginning immediately when you make this investment (the CFs increase starting the same year that you pay the improvement cost) and…
You are considering making a movie. The movie is expected to cost 10.6 million up front and take a year to produce. After that, it is expected to make $4.7 million in the year it is released and $1.8 million for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10.9% ?
Investment Timing Option: Decision-Tree Analysis Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial investment of $15 million. Kim expects the hotel will produce positive cash flows of $2.4 million a year at the end of each of the next 20 years. The project's cost of capital is 15%. What is the project's net present value? A negative value should be entered with a negative sign. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.$ million
How do the various functional departments of an organization use financial planning (i.e. marketing, operations, sales, executive management, finance, etc.)?
You are considering making a movie. The movie is expected to cost $10.1 million up front and take a year to produce. After that, it is expected to make $4.1 million in the year it is released and $1.9 million for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10.9% 7 What is the payback period of this investment? The payback period is years. (Round to two decimal places)
A new computer system will require an initial outlay of $17,500, but it will increase the firm’s cash flows by $3,500 a year for each of the next 8 years. How high can the discount rate be before you would reject the project?
Ivy's Ice Cream is looking at an opportunity that would require an investment of $900,000 today. The investment will provide cash flows of $250,000 in the first year, $400,000 in the second year, and $600,000 in the third year. If the interest rate is 8%, what is the NPV of this investment opportunity? Should Ivy's Ice Cream move forward with this investment based on the NPV? (Round your answer to the nearest whole dollar.)
Your startup has been doing well and you think you’re just a couple of years away from an M&A exit event. You assume you’ll be able to sell the company for about $50mm, the industry average. But you need to raise $3mm now to fund you until then. You’ve received three term sheets, all with the same premoney valuation of $9mm: which one is best, from the standpoint of maximizing the amount of money you will receive from the target exit, and what key reason(s) makes this most favorable? VC Firm: 1.5x participating preferred, no cap Angel Group: Convertible debt, converting at 25% discount to exit value, $18mm conversion value cap Family Office: 3x simple preferred with a $15mm cap
A project that costs $1000 today is expected to have cash flows of $200/year for 10 years. Under these projections, this is a positive NPV project: if your cost of capital is 10%/year, investing $1000 today and earning $200 per year for 10 years yields an NPV of $228.91 (you can verify this yourself, or take my word for it). However, those annual cash flows of $200 are based on the following expectations: A 50% probability that business will be good and the project will earn $300/year, and a 50% probability that business will be bad and the project will earn $100/year. (Note that the expected annual cash flows will be: [0.5 * $300] + [0.5 * $100] = $200/year, as stated above.) Unfortunately, you will not know which state of the world you will be in until you spend the $1000 and start the business; in year 1, after the business opens, you will find out. Obviously, if you open for business and business is good, you will want to stay open for the entire 10 years; if your cost of capital…
You are considering making a movie. The movie is expected to cost $10.1 million up front and take a year to produce. After that, it is expected to make $4.7 million in the year it is released and $1.5 million for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10.1%? What is the payback period of this investment? The payback period is years. (Round to two decimal places.)

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