You are considering a five-year lease on a small restaurant serving light meals, snacks and drinks. The five-year lease will cost £80,000 and the lease will have no value at the end of the five years. The costs of fitting out the restaurant will be £30,000. After five years, you expect the restaurant fittings to have a scrap value of £2,000. You anticipate that net cash inflows from the restaurant will be £35,000 in the first year, £45,000 in the second year, £60,000 in the third year, £65,000 in the fourth year and £55,000 in the final year of operation. You have been approached by a fellow entrepreneur who is also very interested in the restaurant. She has proposed that you pay the £80,000 to take on the lease while she will fit out the restaurant at her own expense and pay you £40,000 per annum as rent and profit share. You expect a return of 12% per annum on any capital that you invest.

You are now uncertain whether you should fit out and run the restaurant yourself or sub-let the restaurant to your fellow entrepreneur. Running the restaurant yourself results in an IRR of 33.84% while allowing your fellow entrepreneur to run the restaurant and pay you rent and a share of the profits generates an IRR of 41.10%.

Required

Evaluate the above alternatives using the payback, ARR and NPV capital investment appraisal techniques. Which of the two options will you choose? In making your decision, you should also consider any other factors that you would take into account in addition to the purely financial considerations.