18 - failure cash flows, plus the cash flow in one year,...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
b. We would abandon the project if the cash flow from selling the equipment is greater than the present value of the future cash flows. We need to find the sale quantity where the two are equal, so: $1,400,000 = ($60)Q(PVIFA16%,9) Q = $1,400,000/[$60(4.6065)] Q = 5,065 Abandon the project if Q < 5,065 units, because the NPV of abandoning the project is greater than the NPV of the future cash flows. c. The $1,400,000 is the market value of the project. If you continue with the project in one year, you forego the $1,400,000 that could have been used for something else. 18. a. If the project is a success, present value of the future cash flows will be: PV future CFs = $60(9,000)(PVIFA16%,9) PV future CFs = $2,487,533.69 From the previous question, if the quantity sold is 4,000, we would abandon the project, and the cash flow would be $1,400,000. Since the project has an equal likelihood of success or failure in one year, the expected value of the project in one year is the average of the success and
Background image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: failure cash flows, plus the cash flow in one year, so: Expected value of project at year 1 = [($2,487,533.69 + $1,400,000)/2] + $420,000 Expected value of project at year 1 = $2,363,766.85 The NPV is the present value of the expected value in one year plus the cost of the equipment, so: NPV = $1,800,000 + ($2,363,766.85)/1.16 NPV = $237,730.04 b. If we couldn t abandon the project, the present value of the future cash flows when the quantity is 4,000 will be: PV future CFs = $60(4,000)(PVIFA16%,9) PV future CFs = $1,105,570.53 The gain from the option to abandon is the abandonment value minus the present value of the cash flows if we cannot abandon the project, so: Gain from option to abandon = $1,400,000 1,105,570.53 Gain from option to abandon = $294,429.47 We need to find the value of the option to abandon times the likelihood of abandonment. So, the value of the option to abandon today is: Option value = (.50)($294,429.47)/1.16 Option value = $126,909.25...
View Full Document

Ask a homework question - tutors are online