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Question - We are examining a new project. We expect to sell 6,200 units per year at $76 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to be $76 Ã- 6,200 = $471,200. The relevant discount rate is 18 percent, and the initial investment required is $1,730,000. After the first year, the project can be dismantled and sold for $1,600,000. Suppose you think it is likely that expected sales will be revised upward to 9,200 units if the first year is a success and revised downward to 4,800 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?
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