You can acquire an existing business for $2 million. You are uncertain about future demand. There is a 40% chance of high demand, in which case the present value of the business will be $3 million. There is a 25% chance of moderate demand, and the associated present value is $1.5 million. Finally, there is a 35% chance of low demand, in which case the present value is $1 million. Draw a decision tree for this problem.

Suppose that the market value of the assets of the business would have a present value of $1.8 million if the business were to be liquidated after the true demand state is known. Draw a decision tree to reflect the abandonment option. Evaluate the alternatives. What is the net present value of the business if you consider the abandonment option? How valuable is the option to abandon?