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Consider an investment opportunity with an option to abandon that requires a $2 million investment...

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Finance

Consider an investment opportunity with an option to abandon that requires a $2 million investment today. In one year, you will find out whether the project is successful. The operating cost is $0.7 million per year going forward. The probability of being successful in year 1 is 20% and in this case the project generates $2.1 million in revenue per year in perpetuity; otherwise, the project will generate nothing. You have the option to abandon --- at the end of year 2, you can close the project down at zero cost. The appropriate cost of capital is 11%. Calculate the following two:

I. The NPV of the investment opportunity WITHOUT the option to abandon.

II. The value of the option to abandon.

The value of the following two is closest to:

a.

I. $ 0 million; II. $ 4 million.

b.

I. $ 0 million; II. $ 3 million.

c.

I. $ 3 million; II. $ 3 million.

d.

I. - $ 4 million; II. $ 3 million.

e.

I. $ 3 million; II. $ 4 million.

f.

I. - $ 4 million; II. $ 4 million.

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