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Unformatted text preview: this case, the NPV of the project would be (note that we are including the rst years cash ow of $500,000)-9 + 4 . 5 1 . 15 =-5 . 087 This is higher than the NPV from continuing the project under the pes-simistic scenario (i.e. Ford loses less by abandoning than by continuing), so if this scenario is realized, Ford should abandon the project. Thus, the correct expected NPV is E [ NPV ] = ( . 5)(6 . 056)-( . 5)(5 . 087) = 0 . 4845 Incorporating the option to abandon in our NPV calculation reveals that the project actually looks good, and should be accepted. Note that without the option to abandon, the (expected) NPV of the project is -0.2175, and with the option to abandon, the NPV of the project is 0.4845. For this reason, we call 0 . 4845-(-. 2175) = 0 . 701822 the value of the option to abandon. 1...
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This note was uploaded on 11/02/2011 for the course ACTSC 371 taught by Professor Wood during the Fall '08 term at Waterloo.
- Fall '08