Problem:
Enrico, the owner of a pizza parlor near a large university campus, is considering opening a shop specializing in quick, inexpensive take-out meals that are low in fat and calories. He'll use a vacant space adjacent to the pizza parlor, Assume that the project requires an initial cash outlay of $100,000. Finance students from the univeristy have taken on the project as a course assignment. They believe that there is a 50% chance that the project will have modest success and return $11,000 per year for the foreseeable future (a perpetuity). On the other hand, there's a 50% chance that the project will be highly successful and produce returns of $20,000 per year in perpetuity. If the restaurant is modestly successful, Enrico will keept it open, but not expand. If it's well received, he will immediately open two more shops at sites close to the sprawling campus. The additional shops would have approximately the same cash flow as the first. Cash flows will be discounted at 10%.
Required:
Question: What is the NPV of the project if it is expanded?
- $100,000
- $500,000
- $300,000
- $600,000
Note: Show all workings.