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ABC is thinking about investing in anew project that has an initial cost of $500,000.The expected incremental after-tax cash flow from the project is 90,000 per year for the next 9 years, with cash flows occurring at the end of each year. ABC estimates the relevant discounting rate to be12%.Ignore depreciation and taxes.
a) What is the NPV of the project?
b) After one year, the estimate of the remaining cash flows will either be revised upward to $180,000per year, or downward to $0 per year. Each revision has an equal probability of occurring. Also after one year, the project's assets can be sold for $100,000. What is the revised NPV, given that ABC can abandon the project after one year?
c) What is the option value of abandonment?
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