Do the following practice questions (for practice not for grading). By doing them correctly, youcan demonstrate your understanding of how abandonment and expansion options areincorporated in project valuation.1. The Newsome Corporation is considering the purchase of a new technology to helpexpand its current sales of axel-rods. The cost of the technology installed is $118,000,000million. The company estimates that the present value as of the end of year one of all itscash flows (including the CF1) is $234,000,000 if the project is successful and$64,500,000 if it's not. The company assigns a 40% chance to success. The RRR or thecost of capital applicable to the project is 13%.a. Given the above information and based on static analysis, should the company goahead with its investment?Answer: No because NPV- $0.92 million=-b. Upon further study the company realizes that, if the project was not successful, itcan stop production and sell the equipment for an after-tax salvage value plusyear-one cash flow of $92,000,000 (i.e. assume $92 million includes the first yearCF). Given this information, should the company go ahead with the investment?Answer: Yes because the NPV is now $13.68 millionc. What is the present value of the option to abandon?Answer: $14.60 million

Net present value:Net Present Value (NPV) is a financial metric used to assess the profitability of…

Answered: 1. The Newsome Corporation is…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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