Calculate the value of the option to abandon the project

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1. The Mini-Max Company has the following cost information on its new prospective project:

Initial investment: $700 Fixed costs: $ 200 per year

Variable costs: $ 3 per unit Depreciation: $ 140 per year

Price: $8 per unit Discount rate: 12 percent

Project life: Three years Tax rate: 34 percent

Assume that it sells the machine for book value at the end of Year 3 so there is no capital gain or loss on the initial investment. How many units per year does it have to sell to break even from an NPV standpoint?

2. You have been asked to evaluate an infinitely lived project. The project has a cost of $100. There is no depreciation. The project has sales of $100 per year forever. The operating expenses will be $54 the first year and will increase by 8 percent every year. The corporate tax rate is 30 percent, and the opportunity cost of capital is 10 percent. The project can be abandoned at any time. Assume that the cost of abandoning the project is equal to zero. When would it make sense to abandon the project? Calculate the value of the option to abandon the project. (Hint: The value of the option to abandon is equal to the NPV of the project with the option minus the NPV of the project without the option.)

Reference no: EM133001719

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