To open a flagship arcade in Capital City plus another arcade in Regional City, will require a capital investment (year 0) of $25,000,000 and a working capital allocation (year 0) of $15,000,000. This buys you the fit-out for the locations, the arcade machines and so forth. The project has a life of 10 years. The working capital is returned at the end of the project.

You have undertaken a marketing survey at a cost of $1,150,000. In the second year of the project (year 2), you will take a smaller follow-up survey to check customer satisfaction. This second survey will cost $200,000.

Every three years, the arcade machines need to be refreshed. These refreshes in year 3, year 6 and year 9 will cost $2,000,000 each time.

Number of customer visits in the first year (year 1) (flagship): 150,000

Number of customer visits in the first year (year 1) (regional): 60,000

Customer visits are expected to grow by 5 percent p.a. (flagship) and 2 percent p.a. (regional).

Customer spending per visit on playing the machines in the first year (flagship): $45

Customer spending per visit on playing the machines in the first year (regional): $30

Customer spending per visit on playing the machines is expected to grow by 2.50 percent p.a. (both locations)

Customer spending per visit on snacks in the first year (all stores): $15

Customer spending per visit on snacks (all stores) is expected to grow by 3 percent p.a.

The flagship store will sell retro themed merchandise (e.g. Atari t-shirts) in its gift shop. Sales of this merchandise are expected to be $100,000 in the first year and grow at 10 percent p.a.

Cost of goods sold (merchandise) is $60,000 in the first year and will grow at the same rate as merchandise sales.

Wages for the twenty permanent staff plus casuals are expected to be $1,500,000 in the first year, growing at 1.50 percent p.a.

Repairs and other variable costs are expected to be $1,250,000 in the first year, growing at 5 percent p.a.

Fixed costs (total for both locations) are $800,000 in the first year, growing at 2 percent p.a.

Depreciation is straight-line to zero.

Taxes are 27.50 percent.

The discount rate is 12 percent.

What is the net present value (NPV) if we allow for the potential of higher risk by raising the discount rate to 19%? Is the project still viable?

Select one:

a.

The NPV is -$12,665,009. Since it is now negative, the project is not viable and will not create market value.

b.

The NPV is -$1,819,667. Since it is now negative, the project is not viable and will not create market value.

c.

Since the internal rate of return remains unchanged, the project is viable and will create market value.

d.

The NPV is $601,422. Since it is still marginally positive, the project is viable and will create market value.