Question

Brewsters is considering a project with a life of 5 years and an initial cost of $120,000. The discount rate for the project is 12%. The firm expects to sell 2,100 units a year at a net cash flow per unit of $20. The firm will have the option to abandon this project after 3 years at which time it could sell the project for $50,000. The firm is interested in knowing how the project will perform if the sales forecasts for years 4 and 5 of the project are revised such that there is a 50% chance the sales will be either 1,400 or 2,500 units a year. What is the NPV of this project given these revised sales forecasts (consider the option to abandon in your analysis)?

Answer 1

NPV of this project given these revised sales

Project continue till 5 year
Period	Calculation	Cash Flow	PV Factor	Calculation	Present value
0	Outflow	($120,000.00)	1	-120000	(120,000.00)
1	2100*$20	$42,000.00	1/1.12	$42000*(1/1.12)	37,500.00
2	2100*$20	$42,000.00	1/1.12^2	$42000*(1/1.12)^2	33,482.14
3	2100*$20	$42,000.00	1/1.12^3	$42000*(1/1.12)^3	29,894.77
4	(1400*.50 + 2500*.50)*$20	$39,000.00	1/1.12^4	$39000*(1/1.12)^4	24,785.21
5	(1400*.50 + 2500*.50)*$20	$39,000.00	1/1.12^5	$39000*(1/1.12)^5	22,129.65
				NPV	27,791.77

if we consider to Abandon the project after 3 years, NPV would be:

Abandon the project after 3 years
Period	Calculation	Cash Flow	PV Factor	Calculation	Present value
0	Outflow	($120,000.00)	1	-120000	(120,000.00)
1	2100*$20	$42,000.00	1/1.12	$42000*(1/1.12)	37,500.00
2	2100*$20	$42,000.00	1/1.12^2	$42000*(1/1.12)^2	33,482.14
3	2100*$20	$42,000.00	1/1.12^3	$42000*(1/1.12)^3	29,894.77
3	sale of Project	$50,000.00	1/1.12^3	$50000*(1/1.12)^3	35,589.01
				NPV	16,465.93

Considering both the option, project should be continued till 5 years.