Shai Co. is considering a four-year project that will require aninitial investment of $12,000. 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%?

$19,976

$18,977

$20,975

$16,980

Points:

Close Explanation

Explanation:

Shai 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.

$21,085

$23,194

$24,248

$20,031

Points:

Close Explanation

Explanation:

What is the value of the option to abandon the project? selector1