Abandonment Evaluation
It is quite possible that after acceptance of project, at a later stage, it may be found that the project is no longer economically viable even if its economic life is not yet over. This is called as abandonment of a project. A periodic abandonment evaluation is conducted at the end of each subsequent year. While evaluating it, two factors have to be considered:
(i) P.V. of Salvage value at the end of each subsequent year
(ii) PV of cash flows from the project for remaining years of the life.
These two values are calculated at the end of each of subsequent years and in case the P.V. Of salvage value is found to be higher, the project may be abandoned; otherwise the firm may continue with proposal. In other words, a project should be abandoned whenever the P.V of salvage value is' greater than the PV of cash flows from the project for remaining years of project life.
While incorporating Abandonment in risk analysis, P.V. of salvage value is compared with Expected P.V. of inflows of subsequent years. If cash flows are moderately correlated, remaining expected P.V. of cash flows will be calculated for each combination of subsequent years. If P.V. of salvage value is greater than any of the combination of subsequent year, project will be abandoned if cash inflow of previous year to that subsequent year pertains to that series and NPV of project will be calculated accordingly.
In this case that series will be closed and salvage value will be added in the inflow of that series and NPV' and Probability will be calculated for that series. However, NPV & Joint Probabilities of remaining series will be calculated as usual. To verify the decision, ENPV of project may be calculated for both the situation i.e, without abandonment and with abandonment.
3.0 Hiller's Model of Risk Analysis:
Hiller has recommended that risk associated with a capital expenditure proposal is shown by the SD & CV of the expected cash flows.
4.0 Hertz's Model of Risk Analysis:
Hertz has recommended simulation technique for risk analysis capital budgeting decisions. Hertz proposes that the distribution be described for each variable, which have bearing on NPV.