Danny zuko is thinking of opening a garage shop. The initial cost of the garage is $75K. If the garage is successful, it will generate annual free cash flows of $30K into perpetuity. If not, Danny will only be able to generate $5K of annual free cash flows.
1. If the probability of success is 40% and the required rate of return is 20%, should Danny invest in the car garage?
2. In researching it further, Danny finds that if the garage doesn't succeed he can sell the equipment in a secondary market. He figures he can sell the assets for $40K after taxes on the first year. Should Danny invest in the garage project? Why? Assume he doesn't get that $5K in the first year.