Abandonment Options

3. Abandonment options Herman Co. is considering a four-year project that will require an initial investment of $5,000. The base-case cash flows for this project are projected to be $12,000 per year. The best-case cash flows are projected to be $19,000 per year, and the worst-case cash flows are projected to be -$3,000 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 12%? o $20,299 o $27,911 o $26,643 o $25,374 Herman 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 $3,000 (at the end of year 2). The $3,000 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 $3,000 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. o $31,717 o $24,822 o $33,096 o $27,580 What is the value of the option to abandon the project?