Use the information below to answer the following question(s):
The owner of the Krusty Krab is considering selling his restaurant and retiring.An investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready for retirement.The owner is considering the following three alternatives:
1.Sell the restaurant now and retire.
2.Hire someone to manage the restaurant for the next year and retire.This will require the owner to spend $50,000 now,but will generate $100,000 in profit next year.In one year the owner will sell the restaurant for $350,000.
3.Scale back the restaurant's hours and ease into retirement over the next year.This will require the owner to spend $40,000 on expenses now,but will generate $75,000 in profit at the end of the year.In one year the owner will sell the restaurant for $350,000.
-If the interest rate is 7%,the alternative with the highest NPV is:
A)Alternative #1 with an NPV of approximately $350,000.
B)Alternative #2 with an NPV of approximately $370,561.
C)Alternative #3 with an NPV of approximately $357,196.
D)Alternative #2 with an NPV of approximately $380,561.

Question

Quizplus · Accepted Answer

To find the NPV of each alternative, we need to calculate the present value of all cash flows using the given interest rate of 7%.

For alternative #1, the NPV is simply the sale price of $350,000, which is the same as the present value.

For alternative #2, the initial cost of $50,000 is a cash outflow in year 0, followed by a cash inflow of $100,000 in year 1 (profit). Then, the sale price of $350,000 is a cash inflow in year 2. Using the NPV formula, we get:

NPV = -50,000 + 100,000/(1+0.07)^1 + 350,000/(1+0.07)^2
NPV = $370,560.74

For alternative #3, the initial cost of $40,000 is a cash outflow in year 0, followed by a cash inflow of $75,000 in year 1 (profit). Then, the sale price of $350,000 is a cash inflow in year 2. Using the NPV formula, we get:

NPV = -40,000 + 75,000/(1+0.07)^1 + 350,000/(1+0.07)^2
NPV = $357,196.05

Therefore, alternative #2 has the highest NPV of $370,560.74 and is the best choice.

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