Question

Assume you have negotiated a deal with a Chick-fil-A to open one of its restaurants in Boulder. The terms of the contract specify that you must open the restaurant either immediately or in exactly one year. If you do neither, you lose the right to open the restaurant at all. It costs $5 million to open the restaurant, regardless of when you open it.

If you wait one year before investing, you will learn whether you got the town approval to add an outdoor patio to the restaurant. If approved, you expect to generate $900,000 in free cash flow the first year after the investment, otherwise you expect to generate only $600,000. The probability of approval is 60%.

If you open the restaurant immediately, you expect to generate $600K in free cash flow the first year and either $600k or $900K in the second year depending in patio approval. Inflation plus the projections about the increase in residents in your neighborhood suggest that cash flows are expected to grow at 2% per year. The appropriate cost of capital, r, for this investment is 12%.

What is the NPV of the project today. You must first figure out whether you should delay or not. Then find NPV based on optimal decision.

Answer 1