Question

Sporthotel problem: 1. Projected outflows First year (Purchase Right, Land, and Permits) $1,000,000 Second Year (Construct building shell $2,000,000 Third Year: (Finish interior and furnishings) $2,000,000 TOTAL $5,000,000 2. Projected inflows If the franchise is granted hotel will be worth: $8,000,000 when it opened If the franchise is denied hotel will be worth: $2,000,000 when it opened. The probability of the city being awarded the franchise is 50%. Assume that everything is the same as in that problem except for one thing: the first year projected outflow is not $1 million but instead is $1.3 million. Given this change, which of the following is true when the franchise is granted?

a. The project’s NPV = $0.60 million

b. The project’s NPV = $1.00 million

c. The project’s NPV = $0.70 million

d. The project’s NPV = $0.90 million

e. The project’s NPV = $0.80 million

Answer 1

In the original Sporthotel problem, the discount rate is zero. Hence, NPV = algebraic addition of cash flows as and when they occur.

Hence, when the franchise is granted, NPV = Sum of cash flows across the four years = - 1.3 - 2.0 - 2.0 + 8 = $ 2.7 million

Hence, none of the answers are correct.