Acme Co. is considering a four-year project that will require an initial investment of $9,000. The base-case cash flows for this project are projected to be $14,000 per year. The best-case cash flows are projected to be $21,000 per year, and the worst-case cash flows are projected to be –$2,500 per year. The company’s analysts have estimated that there is a 50% probability that the project will generate the base-case cash flows. The analysts also think that there is a 25% probability of the project generating the best-case cash flows and a 25% probability of the project generating the worst-case cash flows. A. What would be the expected net present value (NPV) of this project if the project’s cost of capital is 11%? $27,066 $29,773 $28,419 $23,006 Acme now wants to take into account its ability to abandon the project at the end of year 2 if the project ends up generating the worst-case scenario cash flows. If it decides to abandon the project at the end of year 2, the company will receive a one-time net cash inflow of $4,500 (at the end of year 2). The $4,500 the company receives at the end of year 2 is the difference between the cash the company receives from selling off the project’s assets and the company’s –$2,500 cash outflow from operations. Additionally, if it abandons the project, the company will have no cash flows in years 3 and 4 of the project. B. Using the information in the preceding problem, find the expected NPV of this project when taking the abandonment option into account. $27,887 $35,226 $33,758 $29,355 C. What is the value of the option to abandon the project ?

Managerial Accounting

15th Edition

ISBN:9781337912020

Author:Carl Warren, Ph.d. Cma William B. Tayler

Publisher:Carl Warren, Ph.d. Cma William B. Tayler

Chapter12: Capital Investment Analysis

Section: Chapter Questions

Problem 2CMA: Staten Corporation is considering two mutually exclusive projects. Both require an initial outlay of...

See similar textbooks

All parts are under one questions, and per your policy can be answered in full.

8. Abandonment options

Acme Co. is considering a four-year project that will require an initial investment of $9,000. The base-case cash flows for this project are projected to be $14,000 per year. The best-case cash flows are projected to be $21,000 per year, and the worst-case cash flows are projected to be –$2,500 per year. The company’s analysts have estimated that there is a 50% probability that the project will generate the base-case cash flows. The analysts also think that there is a 25% probability of the project generating the best-case cash flows and a 25% probability of the project generating the worst-case cash flows.

A. What would be the expected net present value (NPV) of this project if the project’s cost of capital is 11%?

$27,066

$29,773

$28,419

$23,006

Acme now wants to take into account its ability to abandon the project at the end of year 2 if the project ends up generating the worst-case scenario cash flows. If it decides to abandon the project at the end of year 2, the company will receive a one-time net cash inflow of $4,500 (at the end of year 2). The $4,500 the company receives at the end of year 2 is the difference between the cash the company receives from selling off the project’s assets and the company’s –$2,500 cash outflow from operations. Additionally, if it abandons the project, the company will have no cash flows in years 3 and 4 of the project.

B. Using the information in the preceding problem, find the expected NPV of this project when taking the abandonment option into account.

$27,887

$35,226

$33,758

$29,355

C. What is the value of the option to abandon the project ?

Expert Solution

Trending now

This is a popular solution!

Step by step

Solved in 5 steps with 5 images

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.