Li'l Lucy's Fried Chicken would like to invest $2 million to buy land and build a a restaurant in an area that has been rezoned from agricultural to residential. The company expects a 9% return. The company believes there is a 15% probability that the neighbouring land will be fully developed into family homes resulting in income before depreciation of $800,000 a year. It also believes in a 60% chance that the neighbouring land will be gradually developed resulting in Year 1 income of $150,000, Year 2 income of $200,000, Years 3, 4 and 5 income of $500,000 and Years 6 and 7 income of $800,000. There exists a 25% chance that there will be no development resulting in an income of $150,000 a year from an alternative use of the land. Based on ENPV, should Li'l Lucy's Fried Chicken build the restaurant?

Question

Quizplus · Accepted Answer

The ENPV (Expected Net Present Value) calculation involves discounting the expected cash flows from each scenario by the company's required return rate (9%) and then weighting them by the probability of each scenario occurring. The positive ENPV of $164,207 suggests that the investment is expected to generate value above the cost of capital, making it a financially viable project.

Li'l Lucy's Fried Chicken Would Like to Invest $2 Million