1. 14.

Abandonment value [LO 24.5] We are examining a new project. We expect to sell 7100 units per year at $56 net cash flow per unit for the next 10 years. In other words, the annual cash flow is projected to be $56 × 7100

= $397 600. The relevant discount rate is 14 per cent, and the initial investment required is $1 800 000.

1. What is the base-case NPV?

2. After the first year, the project can be dismantled and sold for $1 200 000. If expected sales are revised based on the first year’s performance, when would it make sense to abandon the investment? In other words, at what level of expected sales would it make sense to abandon the project?

3. Explain how the $1 200 000 abandonment value can be viewed as the opportunity cost of keeping the project in one year.