The question gives the following information:
The Bullshark Arena, a local sports arena and home of the Bullsharks, is looking into upgrading its main restaurant/bar, the Shark Pen. The old facilities were built 20 years ago for $1.5 million and were constructed with an intended useful life of 25 years (SV = 0). However, the facilities are already looking outdated and, as a result, attendance has significantly fallen. The last few years he average annual revenue for the Shark Pen has been $250,000, with $300,000 in average annual expenses, a pattern you expect to continue into the foreseeable future (forever - even beyond the 25 year useful life) should things continue as they have. The upgraded facilities, dubbed the Shark Cage, will require a significant investment in order to achieve the standard to which people have become accustomed in other arenas and will be built with an intended useful life of 15 years. General renovations will cost $1 million dollars (Life = 15 years, SV = 0) and appliances and equipment will result in another $350,000 investment (you are upgrading all of your restaurant and bar appliances) (Life = 15 years, SV = 0). Furniture and décor will be another $300,000 (Life = 10 years, SV = 0). The restaurant will also require an initial investment of $35,000 in order to fully stock the restaurant and bar with food and beverages. You intend to expand your selection of consumables (more selection, higher end items etc.) over time and as a result will have to increase your consumables investment by 10% each year for the life of the project. Once the project is complete you are confident that you will be able to offload the appliances and equipment for $35,000 and the furniture and decor for $30,000. Renovation costs, however, cannot be recovered. You can fund part of the project by selling some of the existing equipment and furniture in the Shark Pen. You will be able to recover $25,000 from the sale of existing assets. Note that the assets sold were part of the original $1.5 million investment. You feel that the new renovations and the opening of the Shark Cage will breathe new life into business, and bring new revenue along with it. You anticipate that revenue for the first year will be $700,000 with $320,000 in annual expenses. You anticipate that the price of expenses will keep up with inflation and that annual expenses will increase by 2% each year. However, you also plan on expanding your services and as a result you anticipate growth in revenue at an average annual rate of 5% per year (normally distributed with a standard deviation of 2%). Unfortunately the Shark Cage will be a bit bigger than the Shark Pen, and as a result you will have to close down the hot-dog stand next door. You expect that this will result in a loss of $30,000 in revenue per year (Expenses will decrease by $10,000 per year as a result of the closure) into the indefinite future. The hot-dog stand would have remained operational for the next 15 years. You could not salvage any of the material from the hot-dog stand, however, it had already been fully depreciated. Your corporate marginal tax rate is 30% and your required rate of return is 25% (annual effective).
A. What is the likelihood of success (NPV >= 0)?
B. What is the highest cost of capital that you can accept and still be successful?