Question
Zyn Company is considering a new project that has a cost of $7,300, and the CEO set up the following simple decision tree to show
Zyn Company is considering a new project that has a cost of $7,300, and the CEO set up the following simple decision tree to show its three most likely scenarios. After t = 0 (or at t = 1), the cash flows will be known. In the high demand (best case) scenario, the cash flows will be $4,000 for 4 years with a 25% probability. In the average demand (base case) scenario, the cash flows will be $2,000 for 4 years with a 60% probability. In the low demand (worst case) scenario, the cash flows will be -$1,000 for 4 years with a 15% probability. The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to obtain this abandonment option, it would have to make a payment to those parties. How much is the option to abandon worth to the firm? Assume that the WACC for this project is 5.5%
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