Question
The Z-90 project being considered by Steppingstone Inc. (SI) has an up-front cost of $250,000. The project's subsequent cash flows are critically dependent on whether
The Z-90 project being considered by Steppingstone Inc. (SI) has an up-front cost of $250,000. The project's subsequent cash flows are critically dependent on whether another of its products, Z-45, becomes an industry standard. There is a 50% chance that the Z-45 will become the industry standard, in which case the Z-90's expected cash flows will be $110,000 at the end of each of the next 5 years. There is a 50% chance that the Z-45 will not become the industry standard, in which case the Z-90's expected cash flows will be $25,000 at the end of each of the next 5 years. Assume that the cost of capital is 12%.
Refer to Exhibit 14.4. Now assume that one year from now SI will know if the Z-45 has become the industry standard. Also assume that after receiving the cash flows at t=1, Si has the option to abandon the project, in which case it will receive additional $100,000 at t = 1 but no cash flows after t = 1, Assuming that the cost of capital remains at 12%, what is the estimated value of the abandonment option?
a.$ 10,745
b.$ 8,945
c.$ 2,075
d.$ 0
e.$ 4,067
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