Abandonment Decisions For some projects, it may be advantageous to terminate the project early. For example, if a project is losing money, you might be able to reduce your losses by scrapping out the assets and terminating the project, rather than continuing to lose money all the way through to the project's completion. Consider the following project of Hand Clapper, Inc. The company is considering a four-year project to manufacture clapcommand garage door openers. This project requires an initial investment of $4 million that will be depreciated straight-line to zero over the project's life. An initial investment in net working capital of $1 million is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $3.5 million in pretax revenues with $1.5 million in total pretax operating costs. The tax rate is 38 percent and the discount rate is 16 percent. The market value of the equipment over the life of the project is as follows: a. Assuming Hand Clapper operates this project for four years, what is the NPV? b. Now compute the project NPV assuming the project is abandoned after only one year, after two years, and after three years. What economic life for this project maximizes its value to the firm? What does this problem tell you about not considering abandonment possibilities when evaluating projects? in the text, we set the project NPV equal to zero and found the required price using the definition of OCF. Thus the bid price represents a financial break-even level for the project. This type of analysis can be extended to many other types of problems. a. In Problem 19, assume that the price per carton is $11 and find the project NPV. What does your answer tell you about your bid price? What do you know about the number of cartons you can sell and still break even? How about your level of costs? b. Solve Problem 19 again with the price still at $11 but find the quantity of cartons per year that you can supply and still break even. Hint: It's less than 150,000 . c. Repeat (b) with a price of $11 and a quantity of 150,000 cartons per year, and find the highest level of fixed costs you could afford and still break even. Hint: It's more than $150,000