Question
Abandonment Option Abandonment option: Consider a 3-year project with a 14.00% cost of capital. The initial investment is $1,000 and the expected cash flows are
Abandonment Option Abandonment option: Consider a 3-year project with a 14.00% cost of capital. The initial investment is $1,000 and the expected cash flows are $400 per year. a. Calculate NPV and determine whether or not to undertake this project. b. Suppose instead that we have more information on the expected cash flows. First, there is a 40.00% probability that the project is a success and the cash flows will be $700 and a 60.00% probability that the project is a failure and the cash flows will be $200. In addition, at the end of the first year, we will know whether the project is a success or a failure. We have the option to abandon the project at the end of the first year and receive the salvage value of $850. First, determine the optimal abandonment strategy. Then calculate the project's NPV and the value of the abandonment option using that strategy.
-NPV without considering abandonment option
-PV of year 2 and year 3 cash flows at the end of year 1 if project is a success
-Optimal abandonment strategy if project is a success
-PV of year 2 and year 3 cash flows at the end of year 1 if project is a failure
-Optimal abandonment strategy if project is a failure
- NPV if project is a success
-NPV if project is a failure
-NPV of the project including option
-Value of the abandonment option
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