Question

(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 initial outlay will be ​$5.8 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 ​$840 comma 000 per year forever​ (a perpetuity), while there is a 50 percent chance of it producing a cash flow of only ​$240 comma 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 10 ​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?

Answer 1