Foundations Of Finance
Foundations Of Finance
10th Edition
ISBN: 9780134897264
Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher: Pearson,
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Chapter 11, Problem 18SP

(Real options and capital budgeting) McDoogals Restaurants has come up with a new fast-food, casual restaurant combining some of the features of Chipotle, Panera, and Shake Shack, but it is not quite sure how the public will react to it. McDoogals feels that there is a 50–50 chance that consumers will like it and a 50–50 chance that they won’t. McDoogals is considering building one of these new restaurants; the cash flows if it succeeds and if it fails are given below.

Chapter 11, Problem 18SP, (Real options and capital budgeting) McDoogals Restaurants has come up with a new fast-food, casual

The required rate of return is 10 percent. What is the NPV of the project if it is successfully received? What is the NPV if it is unsuccessfully received? Now determine the expected NPV from taking on this project given the fact that it has a 50–50 chance of success. If the project is well received by the public, McDoogals expects to build 20 more of these restaurants. The cash flows from these projects will be identical to the cash flows from the successful outcome, with the initial outlay occurring in year 1 rather than year 0 and followed by four annual cash flows of $400,000 each. The one-year delay for the expansion restaurants is a result of the fact that it will take one year to gauge how the public responds to the new restaurant. If it is not well received, then the project will be abandoned after year 4. What is the NPV of the project assuming that 20 additional of these restaurants will be built?

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