Hi there, I need help with these questions. Please use formulas when applicable.

Question

Hi there, I need help with these questions. Please use formulas when applicable. Thanks.

A U.S. chain of upscale seafood restaurants is considering a new market in SouthEastern Asia, focusing on three potential locations. The market analysis revealed that the revenues, and, consequently, earnings in each location will depend on the perception of the chain by the locals. The analysis also revealed that the perception would likely be quite uniform in all three locations. If the restaurants are wellperceived, the Present Value of the earnings over the expected life of the restaurant would be $7M. If they are poorly perceived, the Present Value of the earnings would be $1M in each location. It costs $2.5M in investments to set up each location. Judging by prior experience and statistics on new restaurants, it has been estimated that the likelihood of restaurants being well-perceived is 20%, and correspondingly 80% are the chances of the restaurants being poorly-perceived. Should the company undertake the investment? For your analysis, ignore the taxes and assume a risk-neutral discount rate of 10%.

Explanation / Answer

There are three locations in this case.

Initial investment is $2.5 million in each location.

If well perceived:

Particulars

Per Location

Initial investment

($2,500,000)

Present value

$7,000,000

NPV

$4,500,000

If poorly perceived:

Particulars

Per Location

Initial investment

($2,500,000)

Present value

$1,000,000

NPV

($1,500,000)

If the investment is made there will be a loss of 1,500,000 in each location as the restaurants will be poorly perceived with 80% probability. Hence, investment should not be made.

Particulars

Per Location

Initial investment

($2,500,000)

Present value

$7,000,000

NPV

$4,500,000

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