Question

After lowering the price, Hard Stone believes that it might be wise to expand their restaurant. The expansion will cost $250,000 but their profit will rise by $30,000 a year for the next eight years. The prevailing interest rate is 7 percent. Should they expand? Provide a reason.

Answer 1

We will use present worth method for reaching the decision

We have the following information

P = Initial Cost = $250,000

R = Annual Profit = $30,000

i = Interest rate = 7% or 0.07

n = Number of years = 8

Present Worth: PW(7%) = – Initial Cost + Annual Profit(P/A, i, n)

PW(7%) = – 250,000 + 30,000(P/A, 7%, 8)

PW(7%) = – 250,000 + 30,000[((1+0.07)⁸ – 1)/0.07(1+0.07)⁸]

PW(7%) = – 250,000 + 179,138.96

PW(7%) = – 70,861.04

Since the PW is negative so Hard Stone should not expand the restaurant.