We are examining a new project. We expect to sell 6,500 units per year at $43 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to be $43 × 6,500 = $279,500. The relevant discount rate is 16 percent, and the initial investment required is $980,000. After the first year, the project can be dismantled and sold for $810,000. Suppose you think it is likely that expected sales will be revised upward to 9,100 units if the first year is a success and revised downward to 3,700 units if the first year is not a success. a. If success and failure are equally likely, what is the NPV of the project? Consider the possibility of abandonment in answering. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. What is the value of the option to abandon?
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We are examining a new project. We expect to sell 6,500 units per year at $43 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to be $43 × 6,500 = $279,500. The relevant discount rate is 16 percent, and the initial investment required is $980,000. After the first year, the project can be dismantled and sold for $810,000. Suppose you think it is likely that expected sales will be revised upward to 9,100 units if the first year is a success and revised downward to 3,700 units if the first year is not a success. |
| a. |
If success and failure are equally likely, what is the NPV of the project? Consider the possibility of abandonment in answering. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) |
| b. |
What is the value of the option to abandon?
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