Your brother, Jackson, was laid off from his job with a large and famous software company. He would like to sell his stock in the company and use the proceeds to start a restaurant. The stock is currently valued at $500,000. He received a job offer from a competitor that will pay $90,000 per year plus benefits. He asked you to help him decide the best course of action.
REQUIRED
A. What are the alternatives that Jackson faces?
B. Choose the most appropriate analysis technique and explain your choice.
C. If your brother chooses to open a restaurant, what are his opportunity costs?
D. List the steps you would take to develop a spreadsheet that your brother could manipulate to help with the quantitative aspects of this decision. Assume that you only have time to set up a template and that your brother will fill in the specific information. However, you need to tell him the general categories of information he will need to gather.
E. List uncertainties about whether taking the job offer would turn out well for your brother. List as many uncertainties as you can.
F. List uncertainties about whether opening a restaurant would turn out well for your brother. List as many uncertainties as you can.
G. Explain why it is possible for your brother to make a good decision even though he cannot know for sure how well his alternatives would work out.
SOLUTION
The alternatives described in the problem are:
Hold the stock and work for $90,000 per year
Sell the stock, do not take the job, and start the restaurant
Jackson could consider additional options such as taking time off with or without selling the stock, or selling only part of his stock and raising money from other investors to start the restaurant.
Either IRR or NPV methods could be used for this analysis. The decision is a long-term decision and therefore needs to include the time value of money. Both of these methods do that. With the NPV method, inflation rates for different categories of costs could be used, so the results would be more precise. In addition, it may be easier to understand the differences in these two plans in today’s dollars, rather than in rates of returns.
His opportunity costs are $90,000 plus benefits from the job offer, plus the return on the stock.
The following categories would be set into an input box: Investment amount, risk free rate, risk premium for the restaurant, risk premium for the stock, inflation rate, tax rates, all of the cash flows from the restaurant (revenues and variable and fixed costs). Once these are in the input box, formulas for calculating the incremental cash flows over time need to be set up, and the real cash flows would need to be inflated and then discounted. If depreciation is relevant for the investment, a MACRS table would need to be added.
Uncertainties about a new job include lack of information about the people Jackson would work with, and also about the nature of the work to be done. The future of the company is not guaranteed. Students may have thought of other uncertainties.
Jackson faces uncertainties about customer preferences, which will result in uncertainty about revenues. He has not operated a restaurant, so he faces uncertainties about current costs and cost trends over time. He also faces uncertainties about the quality and quantity of employees available to cook, wait tables, and perform other tasks that need to be done.
Jackson faces many uncertainties, no matter which alternative he chooses. If he performs sensitivity analyses around each alternative and formally incorporates qualitative factors, such as the amount of enjoyment he takes in his current position and his perceptions of this aspect of owning a restaurant, he will be able to make a high quality decision.