Question

The owner of the Krusty Krab is considering selling his restaurant and retiring. An investor has offered to buy the Krusty Krab for​ $350,000 whenever the owner is ready for retirement. The owner is considering the following three​alternatives:

1.Sell the restaurant now and retire.

2.Hire someone to manage the restaurant for the next year and retire. This will require the owner to spend​ $50,000 now, but will generate​ $100,000 in profit next year. In one year the owner will sell the restaurant for​ $350,000.

3.Scale back the​ restaurant's hours and ease into retirement over the next year. This will require the owner to spend​$40,000 on expenses​ now, but will generate​ $75,000 in profit at the end of the year. In one year the owner will sell the restaurant for​ $350,000.

If the discount rate is​ 15%, then the alternative which the owner should choose​ is:

Answer 1

Option 1: Sell the restaurant now and retire

NPV of the option 1 is $350,000

Option 2: manage restaurant for next year and retire

NPV of the Option 2 = -$50,000 + [$100,000 / (1+15%)^1] + [$350,000 / (1+15%)^1]

= -$50,000 + [$100,000 / 1.15] + [$350,000 / 1.15]

= -$50,000 + $86,956.5217 + $304,347.826

= $341,304.348

NPV of the Option 2 is $341,304.35

Option 3: Scale up restaurant for next year and retire

NPV of the Option 3 = -$40,000 + [$75,000 / (1+15%)^1] + [$350,000 / (1+15%)^1]

= -$40,000 + [$75,000 / 1.15] + [$350,000 / 1.15]

= -$40,000 + $65,217.3913 + $304,347.826

= $329,565.217

NPV of the Option 3 is $329,565.22

NPV of the Option 1 is higher than Option 2 and Option 3

Hence, it is better to sell the restaurant now and retire