. Joe Avery recently graduated from college and has an idea for a juice shop using...

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Finance

. Joe Avery recently graduated from college and has an idea fora juice shop using only organic and locally-sourced ingredients. Hehas saved just enough money to cover the initial investmentrequired to open the shop, $40,000. Using his corporate financetraining, he estimates that the free cash flow from the shop willbe $4,000 per year, forever. Consider a rate of return of 15%.
a. What is the NPV of the project?
b. In fact, the annual cash flow of $4,000 is an expected value:there is a 50% chance that annual cash flow will be $10,000 and a50% chance that it will be -$2,000. Because of a very restrictiveleasing contract, he cannot close down the shop even if there is nodemand. What is the expected NPV of the project?
c. Fortunately, Joe's relatives are willing to provide him withenough capital to open another 10 shops after the first year ifthere is a lot of demand. What is the true NPV of the project?
d. What is the value of the option to expand?

Answer & Explanation Solved by verified expert

3.9 Ratings (764 Votes)

a NPV of the project is calculated by computing the difference between the present value of Inflows and present value of Outflows PV of Outflow is given as 40000 PV of Inflow 400015 26667 rounded off So NPV 2666740000 13333 b There are 50 chances of 10000 and 50 See Answer

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Transcribed Image Text

. Joe Avery recently graduated from college and has an idea fora juice shop using only organic and locally-sourced ingredients. Hehas saved just enough money to cover the initial investmentrequired to open the shop, $40,000. Using his corporate financetraining, he estimates that the free cash flow from the shop willbe $4,000 per year, forever. Consider a rate of return of 15%.a. What is the NPV of the project?b. In fact, the annual cash flow of $4,000 is an expected value:there is a 50% chance that annual cash flow will be $10,000 and a50% chance that it will be -$2,000. Because of a very restrictiveleasing contract, he cannot close down the shop even if there is nodemand. What is the expected NPV of the project?c. Fortunately, Joe's relatives are willing to provide him withenough capital to open another 10 shops after the first year ifthere is a lot of demand. What is the true NPV of the project?d. What is the value of the option to expand?