$3.$ Abandonment options

Albert Co$.$ is considering a four$-$year project that will require an initial investment of $$15,000.$ The base$-$case cash flows for this project are projected to be $$14,000$ per year. The best$-$case cash flows are projected to be $$21,000$ per year, and the worst$-$case cash flows are projected to be $$$$2,500$ per year. The company$$s analysts have estimated that there is a $50\%$ probability that the project will generate the base$-$case cash flows. The analysts also think that there is a $25\%$ probability of the project generating the best$-$case cash flows and a $25\%$ probability of the project generating the worst$-$case cash flows.

What would be the expected net present value $($NPV$)$ of this project if the project$$s cost of capital is $11\%?$

$$23,173$

$$22,119$

$$16,853$

$$21,066$

Albert now wants to take into account its ability to abandon the project at the end of year $2$ if the project ends up generating the worst$-$case scenario cash flows. If it decides to abandon the project at the end of year $2,$ the company will receive a one$-$time net cash inflow of $$4,500($at the end of year $2).$ The $$4,500$ the company receives at the end of year $2$ is the difference between the cash the company receives from selling off the project$$s assets and the company$$s $$$$2,500$ cash outflow from operations. Additionally, if it abandons the project, the company will have no cash flows in years $3$ and $4$ of the project.

Using the information in the preceding problem, find the expected NPV of this project when taking the abandonment option into account.

$$28,026$

$$21,020$

$$23,355$

$$26,858$

What is the value of the option to abandon the project?