Question

Albert Co. is considering a four-year project that will require an initial investment of $9,000. The base-case cash flows for this project are projected to be $12,000 per year. The best-case cash flows are projected to be $20,000 per year, and the worst-case cash flows are projected to be –$1,000 per year. The company’s analysts have estimated that there is a 50% probability that the project will generate the base-case cash flows. The analysts also think that there is a 25% probability of the project generating the best-case cash flows and a 25% probability of the project generating the worst-case cash flows.

What would be the expected net present value (NPV) of this project if the project’s cost of capital is 11%?

$24,351

$19,481

$25,569

$20,698

Albert now wants to take into account its ability to abandon the project at the end of year 2 if the project ends up generating the worst-case scenario cash flows. If it decides to abandon the project at the end of year 2, the company will receive a one-time net cash inflow of $4,000 (at the end of year 2). The $4,000 the company receives at the end of year 2 is the difference between the cash the company receives from selling off the project’s assets and the company’s –$1,000 cash outflow from operations. Additionally, if it abandons the project, the company will have no cash flows in years 3 and 4 of the project.

Using the information in the preceding problem, find the expected NPV of this project when taking the abandonment option into account.

$29,570

$25,713

$24,427

$23,142

What is the value of the option to abandon the project?     

$1,362

$885

$1,090

$1,430

$1,498

Answer 1