You work for Soon! as a capital-budgeting analyst. Soon! is considering the development of an exotic forest, requiring an outflow of $1400 at t=0. If fully developed and used, the forest will expire in 11 years, with cash flows at t=8 through t=11. You will not know whether the forest will be a success or a failure, until new information emerges at t=7. You forecast that, if the forest looks to be a success, cash flows from t=8–11 will be $2200, $2600, $3000, & $2600 respectively. If the endeavor looks to be a failure, the same four cash flows will be $1100, $1300, $1500, and $1300. Your firm has the option, at t=7, to abandon by selling the forest to CBS’s “Survivor” television show for $4000. Probabilities are forecasted as 63% for success and 37% for failure. Using a required return for this project is 16%/year, your task is to calculate (a) the expected NPV of this project with the abandonment option and (b) the value that the abandonment option (i.e., the option to sell the forest to CBS’s “Survivor” television show) contributes to the forest project.
You work for Soon! as a capital-budgeting analyst. Soon! is considering the development of an exotic forest, requiring an outflow of $1400 at t=0. If fully developed and used, the forest will expire in 11 years, with cash flows at t=8 through t=11. You will not know whether the forest will be a success or a failure, until new information emerges at t=7. You
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