Question
ABC is considering a new product. The demand for this product has high uncertainty. If it is a hit, ABC will have net cash flows
ABC is considering a new product. The demand for this product has high uncertainty. If it is a hit, ABC will have net cash flows of $62 million per year for three years (starting next year [i.e., at t = 1]). If it fails, ABC will only have net cash flows of $22 million per year for two years (also starting next year). There is an equal chance that it will be a hit or failure. ABC will not know whether it is a hit or a failure until the end of year 1. ABC must spend $104 million immediately on equipment. The discount rate is 10 percent. If ABC can sell your equipment for $87 million at the end of year 1, what is the value of the abandonment option? [round to 2 decimal places, in million. For example, if the answer is $1.5 million, write down 1.50.]
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