12. Abandonment options (S23.3) In Section 10-3, we considered two production technologies for a new outboard motor. Technology A was the most efficient but had no salvage value if the new outboards failed to sell. Technology B was less efficient but offered a salvage value of $17 million.

Figure 10.2 shows the present value of the project as either $24 or $16 million in year 1 if Technology A is used. Assume that the present value of these payoffs is $18 million at year 0.

688 Part Seven Options

a. With Technology B, the payoffs at year 1 are $22.5 or $15 million. What is the present value of these payoffs in year 0 if Technology B is used? (Hint: The payoffs with Technology B are 93.75% of the payoffs from Technology A.)