Abandonment Decisions $($LO$1,2)$ 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

Norman Clapper Inc. The company is considering a four$-$year project to manufacture clap$-$command garage door openers.

This project requires an initial investment of $$7$ million with a CCA of $40\%$ over the project's life. An initial investment in

net working capital of $$2$ million is required to support spare parts inventory; this cost is fully recoverable whenever the

project ends. The company believes it can generate $$5$ million in pre$-$tax revenues with $$2\mathrm{.}5$ million in total pre$-$tax

operating costs. The tax rate is $39\%$ and the discount rate is $13\%.$ The market value of the equipment over the life of the

project is as follows:

a$.$ Assuming Norman 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?