We are examining a new project. We expect to sell 5,200 units per year at $66 net cash flow apiece for the next 10 years. In other words, the annual cash flow is projected to be $66 × 5,200 = $343,200. The relevant discount rate is 17 percent, and the initial investment required is $1,510,000. After the first year, the project can be dismantled and sold for $1,230,000. Suppose you think it is likely that expected sales will be revised upward to 8,200 units if the first year is a success and revised downward to 3,800 units if the first year is not a success.
a.If success and failure are EQUALLY LIKELY, what is the NPV of the project? Consider the possibility of abandonment in answering.
b.What is the value of the option to abandon?