Long Term v. Short Term Investment | Retail and License

Question

Hey there!

I was posed a tough question on a 'go - no go' decision on investments

Scenario:

Our client is a large company that operates airport restaurants. It is currently considering an investment for an additional restaurant in Milan airport
In this particular restaurant, the BP shows that we can get 10% profit in a year. Our benchmark 'company' profit on our investments is also 10% a year
Of course, this investment has some up-front: license, cooking equipment, area setting

Question:

How would you consider this investment if we consider that the license is valid only for 1 year (after that, we are not sure we'll be able to extend it) ?

How would you consider this investment if the license were valid for 5 years (profit stays the same: 10% a year)?

My View (in short)

One-Year Investment It doesn't seem to clever to invest to get our average return for one-year only, because the investment may have significant up-front costs (cooking equipment, license, etc.) that harm the financial sustainability/value of it, putting at least under comparable benchmarks --> I would advise against, unless long term strategic pros emerge
Five-Year Investment We know that this is a quintessential 'basic' investment for the company. So investing or not investing is the same: barring demand issues or other barriers, there will be other alternative investments with the same rate. --> I would consider the 'strategic value' of this investment (e.g. we want to increase our presence in the Italian market): if this investment is 'above-average strategic', I would say yes; if it's 'below-average strategic', I would say no.

What do you guys think? I am really looking forward to hear your smart point of views :)

Thank you

Anonym0us

Answer 1

Hi Anonymous,

thanks for your thoughts and the interesting, since very hypothetical and detailed question.

I think the key concepts you are working towards here is a) opportunity cost of choosing this investment and b) return on investment.

In the context here, I would ask the interviewer for three key aspects to determine that:

Total size of the investment: 10% profit is great, but what is the size of the investment? Is there also a benchmark for the size of the usual investments that this company makes and where does the Milan airport restaurant stand on this list? This would give us an idea as to how much sunk cost we would create
Portion of upfront investments: In relation to the total investment, what portion of that does a) the license and b) other upfront sunk cost such as the real estate agent take?
Amount of other available investments: are investment opportunities limited or not? This would help us to put the value of the opportunity in Milan into context.

Answering these three we would get closer to make a quantified comment on the opportunity cost of foregoing this investment and on how long we would need to have the license to be valid for

Do you have any info on the above?

Best, Christian