Question

dismayed at the lack of coffee shops in the queens area, you decide to open a franchise in Astoria. you will need $650,000 for the shop up front, and expect profits to be $40,000 per year forever. you also intend to own the store indefinitely. if you dont buy the shop, you will leave the $650,000 in a mutual fund earning 4.5%. find the IRR rounded to two decimal points of the coffee shop and based on the number you calculate explain whether you should buy it.

Answer 1

The IRR of the coffee shop investment is 6.15%, which is higher than the mutual fund's return of 4.5%. Therefore, from a purely financial perspective, purchasing the franchise may be the better investment given the higher rate of return. This assumes annual profits are stable and does not account for any additional costs or potential profit increases.

Step-by-step explanation:

To determine if purchasing a coffee shop in Astoria is a good investment, we calculate its internal rate of return (IRR). The IRR is the discount rate that makes the net present value (NPV) of the cash flows from the investment equal to zero. In this case, the initial investment is $650,000, and the expected annual profit is $40,000 indefinitely.

To find the IRR, we use the formula for a perpetuity: Annual Profit / Initial Investment. Plugging in the values, we get $40,000 / $650,000 = 0.0615 or 6.15%. Since the IRR of 6.15% is higher than the mutual fund's return of 4.5%, it suggests that investing in the coffee shop could be a better option.

However, this analysis assumes that the $40,000 annual profits are guaranteed forever and does not take into account any potential increases in profit or additional costs. It is also important to consider implicit costs, such as foregoing the returns from the mutual fund, or, in other scenarios, giving up a current job that provides a steady income.