What is the value of the option to abandon

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Reference no: EM131063200

We are examining a new project. We expect to sell 5,100 units per year at $65 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to be $65 × 5,100 = $331,500. The relevant discount rate is 15 percent, and the initial investment required is $1,500,000. After the first year, the project can be dismantled and sold for $1,220,000. Suppose you think it is likely that expected sales will be revised upward to 8,100 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.

b. What is the value of the option to abandon?

Reference no: EM131063200

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