Question

Joe and Jan are thinking of opening an Italian restaurant. Setting up the restaurant is very expensive and costs $400,000 today and $200,000 the first year. However, they expect to earn $150,000 their first year, $130,000 the next year, $100,000 the third year, $200,000 the fourth year, and a whopping $300,000 their fifth year.

If interest rates are currently 10%, should they open the restaurant of their dreams?

Answer 1

The answer is that they can open the restaurant of their dreams. The reason is because, the Net present value is positive. If the restaurant runs for more than five years, it is obvious that the restaurant earns profit. The calculation is given below.

NPV = PV of cash outflow - PV of cash inflow

Year	Cash outflow	Cash inflow	Net cash outflow	Present value @ 10%	PV of Cashflow
0	(400,000.00)	-	(400,000.00)	1.0000	(400,000.00)
1	(200,000.00)	150,000.00	(50,000.00)	0.9091	(45,454.55)
2	-	130,000.00	130,000.00	0.8264	107,438.02
3	-	100,000.00	100,000.00	0.7513	75,131.48
4	-	200,000.00	200,000.00	0.6830	136,602.69
5	-	300,000.00	300,000.00	0.6209	186,276.40
				Net present value	59,994.04