Herman Co. is considering a four-year project that will requirean initial investment of $5,000. The base-case cash flows for thisproject are projected to be $12,000 per year. The best-case cashflows are projected to be $20,000 per year, and the worst-case cashflows are projected to be –$1,000 per year. The company’s analystshave estimated that there is a 50% probability that the projectwill generate the base-case cash flows. The analysts also thinkthat there is a 25% probability of the project generating thebest-case cash flows and a 25% probability of the projectgenerating the worst-case cash flows.

What would be the expected net present value (NPV) of thisproject if the project’s cost of capital is 13%?

A. $25,627

B. $26,976

C. $31,022

D. $22,930

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

Using the information in the preceding problem, find theexpected NPV of this project when taking the abandonment optioninto account.

A. $35,106

B. $30,894

C. $28,085

D. $26,681

What is the value of the option to abandon the project? ($1,109,$998, $721, $943, $832)