Suppose you are planning on becoming a vendor at the arena
where your favorite sports team plays. You are trying to decide
between opening up a souvenir stand selling T-shirts, caps, etc.,
with your sports team’s logo or opening up a hot dog and beer
stand. It is more expensive to open up the hot dog and beer stand
because you need to purchase a license to serve alcohol and you
need to spend money to comply with health department regulations.
Revenue from the souvenir stand is likely to be unpredictable
because fans of your favorite team tend to want to purchase hats
and T-shirts only when the team is winning. Revenue from hot dogs
and beer seem to be a little more steady since fans want to eat and
drink regardless of whether the team is winning.
Below is a table with the initial investment cost of each type
of stand and the annual payments you expect over the next five
years. The annual payments will be different depending on how well
your team does. Therefore, you will estimate how much cash flow you
will get depending on whether your team does better than expected
(optimistic), the same as the past few years (most likely), and
worse than expected (pessimistic). Use a discount rate of 8%.
Based on the table below, answer the following items:
Calculate the net present value (NPV) for each type of stand
under each of the three scenarios. Calculate the range of possible
NPV values for each type of stand.
Based on your answer to A) above and your own guesses about
how well you think your favorite team will do over the next five
years, which type of stand would you rather invest in? USE EXCEL
SPREADSHEET
Souvenir Stand
Hot Dog and Beer Stand
Initial Investment
$100,000
$150,000
Annual Cash Inflows (5 Years)
Outcome
Pessimistic
$30,000
$50,000
Most likely
$50,000
$60,000
Optimistic
$70,000
$70,000