Your company is considering the purchase of new equipment. Consultants have been hired to examine the...

Your company is considering the purchase of new equipment. Consultants have been hired to examine the feasibility of the project. The preliminary, investigative stage will last one year and cost $500,000. There is a 70% chance that this phase will be successful. If the initial phase is not successful, the company will cease activity related to this project.

If the initial phase is successful, the company will spend $1,000,000 for equipment. The equipment is expected to have a five-year life and will be depreciated straight line to zero. The new equipment will generate sales of $700,000/year and cost $150,000/year to operate. Assume a cost of capital of 15% and a tax rate of 30%.

What is NPV at time 1?

What is the expected payoff at time 1?

What is NPV at Time 0?

Now suppose there is an option to abandon at Time 1. Analysis and data generated during the investigative stage can be sold for $100,000. What is the value of this option to abandon?

(Yes, time 1 is the correct question. This is not a typo).

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genius_generous answered 1 year ago

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