Long Term v. Short Term Investment | Retail and License

Finance Investment Retail
New answer on Apr 16, 2020
1 Answer
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Anonymous A asked on Apr 16, 2020

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:

  1. 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) ?
  2. 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

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Christian
Expert
replied on Apr 16, 2020
Ex-Roland Berger | Recruiter in 80+ Interviews | INSEAD Case Coach | Focus: in-case behaviors that persuade ANY interviewer

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

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Anonymous A on Apr 16, 2020

Hi Christian, thank you for the comment. These are 3 very interesting drivers I should consider. Can you elaborate on how (in general) they impact our decision? Thank you so much!

Anonymous A on Apr 16, 2020

In any case, we don't have precise data, but we can guess some more info: 1) Total size of the investment additional revenues would be 0.5% on the company total, the company already has 200 similar airport/station restaurants; 2) Around 15%, equally split between the license and the cooking equipment; 3) Not limited, we are active in all the EMEA market and these opportunities arise quite often, let's say 10-15 times a year (also: no-Covid19 scenario)

Christian on Apr 17, 2020

Hi Anonymous, since this gives us relevant info on the return on investment (15% for the license and cooking one time vs. 10% profit per year), i would go ahead and make a quick ROI calculation for both scenarios, 1 and 5 year investment. The results would support the points you put across as well (1-year rather no, 5-years possibly yes). Maybe to top off the argumentation, make an assumption on how long licenses usually last in other opportunities - that would seem more quantitative than using only the strategic value of the investment (which is also valid considering b2c brand awareness in the market, but difficult to quantify)

(edited)

Christian gave the best answer

Christian

Ex-Roland Berger | Recruiter in 80+ Interviews | INSEAD Case Coach | Focus: in-case behaviors that persuade ANY intervie
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