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(Real options and capital budgeting) McDoogals Restaurants has come up with a new fast-food, casual restaurant combining some of the features of Chipotle, Panera, and Shake Shack, but it is not quite sure how the public will react to it. McDoogals feels that there is a 50–50 chance that consumers will like it and a 50–50 chance that they won’t. McDoogals is considering building one of these new restaurants; the cash flows if it succeeds and if it fails are given below.
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- Question: . What is the estimated Internal Rate of Return (IRR) of the project? Should the project be accepted based on the IRR criterion? Why? You have determined in your mind that you would like to have a business of your own, although your father runs a family restaurant in your local city. You have therefore, decided to have a medium size snack and cocktails bar which will accommodate the cruise ship passengers who visit your city. You plan to keep the business for five years after which you will sell it off to your brother John for $2,000,000 and go off to do your Master’s Degree in the UK. Though you will be occupying the establishment from your grandmother for free, you have decided that you need to make some improvements to the property which will cost you $1,500,000. Additionally, you will spend $275,000 in bar stools, tables and decorations. If this space had been leased out, it would have fetched a lease rental of $75,000 per year. You will depreciate the assets over 7…arrow_forwardMad Scientist, Inc. is considering investing into the nanotechnology business. After conducting a detailed due diligence process, the company's board decided that the current cost of entry into the nanotechnology business is too high. The board also thinks that the commercialization of technological advancements will eventually drive costs down and the company should get into the nanotech business one or two years from now, when they can realize a higher NPV on their investment. Given the above, the board has chosen the option to: Expand Abandon Delayarrow_forward. Dawson Electronics is a manufacturer of high-tech control modules for lawn sprinkler systems. Denise, the CEO, is trying to decide if the company should develop one of two potential new products, the Water Saver 1000 or the Greener Grass 5000. With each product, Dawson can capture a bigger market share if it chooses to expand capacity by buying additional machines. Given different demand scenarios, their probabilities of occurrence, and capacity expansion versus no change in capacity, the potential sales of each product are summarized in Table 5.50. Table 5.5 Demand and Sales Information for Dawson Electronics Low Demand. Medium Demand High Demand Low Demand Medium Demand High Demand Water Saver 1000 Dollar Sales ($1,000) With Capacity Expansion 1,000 2,000 3,000 700 Greener Grass 5000 Dollar Sales ($1,000) 1,000 2,000 2,500 Without Capacity Expansion 3,000 5,000 1,000 2,000 3,000 Probability of Occurrence 0.25 0.50 0.25 0.25 0.50 0.25 a. What is the expected payoff for Water Saver…arrow_forward
- Please solve the question below. Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles (who wants to ride on a cloudy day anyway?) The proposed project has the following features; • The firm just spent $300,000 on a marketing study to determine consumer demand (@ t=0). • Aero Motorcycles purchased the land the factory will be built on 5 years ago for $2,000,000 and owns it outright (that is, it does not have a mortgage).The land has a current market value of $2,913,027. • The project has an initial cost of $20,000,000 (excluding land, hint: the land is not subject to depreciation). • If the project was undertaken, at t = 0 the company will need to increase its inventories by $3,500,000, accounts receivable by $1,500,000, and its accounts payable by $2,000,000. This net operating working capital will be recovered at the end of the project’s life (t =10). • If the project is undertaken, the…arrow_forwardA company is going to start a pop-up venture. The goal is to break-even and use the experience to learn about how consumers react to types of green products. The project will cost $2,000 to implement and will have after-tax cash flows of $200 at the end of Year 1 and $2,200 after Year 2. At that time the project will end. The $2,000 investment will be financed 50% debt and 50% equity. The before-tax cost of debt is 8%. The tax rate is 20%. The beta for the project is 1.2. The risk-free rate for computing the cost of equity is 5.2% and the market risk premium is 7%. Use this information to: Find the WACC for the project. Show that this is a zero NPV project. Show that debtholders and shareholders both earn their minimum required rates of return. Year Cash flow Present Value to Debt to Equity 0 -2000 1 200 2 2200arrow_forwardThe managers of Soup Inc. consider the opportunity to open a new soup restaurant in a small college town. As of today, the best estimate of the value of the future cash flows (in present value terms) generated by the soup store is $12,000. Moreover, to make the store fully operational and actually start selling soup, the firm needs to invest $15,000. Thus, it appears that the restaurant is a negative NPV project. However, the managers of Soup Inc. believe that the potential of the restaurant is uncertain and the current estimate of the value of its cash flows of $12,000 might be quite wrong. Therefore, they decide to invest in market research. They will study the market for 2 years and then decide whether to open the restaurant or not (at the end of year 2). Your task is to help the managers of Soup Inc. by providing answers to the following questions: (Part 1) Investing in market research creates an option. Briefly describe the underlying for the option and the key source of…arrow_forward
- When McDonalds consider the new store, the management know that KFC might also considering opening a new store at the same place. McDonalds predicts that the future cash flow will be 630,000 with probability 50% if KFC does not open a new store, and 210,000 with probability 50% if KFC does. Should McDonalds undertakes the project?arrow_forwardBoyd Enterprises is considering developing a new baseball souvenir for use in the new baseball stadium. It is very big, very bright, and very noisy! Boyd will immediately spend $50,000 on a design and test marketing study that will take a year to complete. If the fan focus groups hate it (30% probability) Boyd will abandon the project and receive nothing. If they love it (70% probability) then in Year 1 Boyd will invest $30,000 in new manufacturing equipment. Sales will begin in Year 2. If actual fans in the stadium love it (80% probability), Boyd will receive cash flows of $40,000 per year for 5 years starting in Year 2. If fans don't like them (20% probability) Boyd will only receive cash flows of $2,000 per year for 5 years. What is the expected NPV of the project? Boyd's WACC is 10%. Hint: Draw a decision tree. $9,068.22 $9,975.04 $10,972.55 $12,069.80 $13,276.78arrow_forwardChan’s Spring Roll (CSR), a seller of frozen spring roll, is considering introducing a healthier version of its product that will be low in sugar and gluten-free. The firm expects that sales of the new spring roll will be $20 million per year. While many of these sales will be to new customers, CSR estimates that 50% will come from customers who switch to the new, healthier spring roll instead of buying the original version. Suppose that 25% of the customers who would switch from CSR’s original spring roll to its healthier version will switch to another brand if CSR does not introduce a healthier spring roll. What level of incremental sales is associated with introducing the new spring roll in this case? $15 million $10 million $17.5 million $12.5 millionarrow_forward
- HomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and Gamma companies) who would like to provide buildings for the new stores. The amount of expected revenue from the stores will depend on the design of the contractor. For example, if HomeGrown decides on a more open floor plan, with less shelf space for products, revenue would be lower overall. However, if HomeGrown decides on a very crowded floor plan, it may lose customers who appreciate a more open feel. As the project manager for HomeGrown, you are responsible for deciding which if any of the proposals to accept. HomeGrown's minimum acceptable rate of return is 20%. You receive the following data from the three contractors: Proposal Type of Floor Plan Initial Cost if Selected…arrow_forwardHomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and Gamma companies) who would like to provide buildings for the new stores. The amount of expected revenue from the stores will depend on the design of the contractor. For example, if HomeGrown decides on a more open floor plan, with less shelf space for products, revenue would be lower overall. However, if HomeGrown decides on a very crowded floor plan, it may lose customers who appreciate a more open feel. As the project manager for HomeGrown, you are responsible for deciding which if any of the proposals to accept. HomeGrown's minimum acceptable rate of return is 20%. You receive the following data from the three contractors: Proposal Type of Floor Plan Initial Cost if Selected…arrow_forwardHomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and Gamma companies) who would like to provide buildings for the new stores. The amount of expected revenue from the stores will depend on the design of the contractor. For example, if HomeGrown decides on a more open floor plan, with less shelf space for products, revenue would be lower overall. However, if HomeGrown decides on a very crowded floor plan, it may lose customers who appreciate a more open feel. As the project manager for HomeGrown, you are responsible for deciding which if any of the proposals to accept. HomeGrown's minimum acceptable rate of return is 20%. You receive the following data from the three contractors: Proposal Type of Floor Plan Initial Cost if Selected…arrow_forward
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