What is the NPV of the project if it is expanded?
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 will 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 university 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 is 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 keep it open, but not expand. If it is well received, he will immediately open 2 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%.
A) $100,000
B) $500,000
C) $300,000
D) $600,000
Answer: C
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