Question

Western Industrial Products is considering a project with a five-year life and an initial cost of $110,000. The discount rate for the project is 13 percent. The firm expects to sell 2,400 units a year. The cash flow per unit is $25. The firm will have the option to abandon this project at the end of year three (after year three's sales) at which time the project's assets could be sold for an estimated $55,000. The firm should abandon the project at the end of year three if the expected level of annual sales, starting with year 4, falls to _____ units or less. Ignore taxes.

1,443 units

2,230 units

928 units

375 units

1,319 units

Answer 1

My working is little different from the options below : Please have a look and get back to me for any clarification or question. I need to find the units sold in year 4 so that at the unit overall NPV = 0, Below which NPV will be negative and it will be better to sell at 3 years. After trial error I found that unit at year 4 will be 2202 at which NPV =0

Year	Unit sold	Price/ Unit	CasgFlow(CF)	Depriciation Exp	Initial Investment	Salvage Value	Total CF
T	Q	P	CF = Px Q	D= I/5	I	S	TCF = CF+I+S+D
0	$                    -	$       25.00	$                              -	$                              -	$         -1,10,000.00	$                     -	$      -1,10,000.00
1	$       2,400.00	$       25.00	$              60,000.00	$             -22,000.00	$                             -		$            38,000.00
2	$       2,400.00	$       25.00	$              60,000.00	$             -22,000.00	$                             -		$            38,000.00
3	$       2,400.00	$       25.00	$              60,000.00	$             -22,000.00	$                             -	$                     -	$            38,000.00
4	$       2,202.39	$       25.00	$              55,059.81	$             -22,000.00	$                             -		$            33,059.81
				NPV	$                             -

Now see if we sell it at 3 years thete will be positive NPV = 38117

Year	Unit sold	Price/ Unit	CasgFlow(CF)	Depriciation Exp	Initial Investment	Salvage Value	Total CF	Cost fo Capital
T	Q	P	CF = Px Q	D= I/5	I	S	TCF = CF+I+S+D	r
0	$                    -	$       25.00	$                              -	$                              -	$         -1,10,000.00	$                     -	$      -1,10,000.00	13%
1	$       2,400.00	$       25.00	$              60,000.00	$             -22,000.00	$                             -		$            38,000.00
2	$       2,400.00	$       25.00	$              60,000.00	$             -22,000.00	$                             -		$            38,000.00
3	$       2,400.00	$       25.00	$              60,000.00	$             -22,000.00	$                             -	$      55,000.00	$            93,000.00
4	$       2,202.39	$       25.00	$              55,059.81	$             -22,000.00	$                             -		$            33,059.81
				NPV	$              38,117.76

Hence, if units fal below 2202 at 4th year, it is worth of elling.

----------------------------------