Georgetown Corporation is considering a new hydraulic power. The asset requires
ID: 1171177 • Letter: G
Question
Georgetown Corporation is considering a new hydraulic power. The asset requires an initial outlay of $1,000 and then generates cash benefits at the end of each year for the next 3 years. The value that can be obtained on abandonment declines from $700 at the end of the first year to $50 at the end of the third year. This abandonment analysis is shown below.
The optimal life of this project using a 10% required return is:
YEAR 0 1 2 3 K Cash flow -$1,000.00 $500.00 $450.00 $300.00 10% Salvage value at the end of year t $700.00 $350.00 $50.00Explanation / Answer
If abandoned at Year 1
NPV = Present Value of Cash Inflows – Present Value of Cash Outflows
Year
Cash Flow
PVF@10%
PV
0
(1000)
1
(1000)
1
500+700
0.909
1091
NPV
91
If abandoned at Year 2
Year
Cash Flow
PVF@10%
PV
0
(1000)
1
(1000)
1
500
0.909
455
2
450+350
0.826
661
NPV
116
If abandoned at Year 3
Year
Cash Flow
PVF@10%
PV
0
(1000)
1
(1000)
1
500
0.909
455
2
450
0.826
372
3
300+50
0.751
263
NPV
90
Hence, the optimal life is 2 years i.e. c
Year
Cash Flow
PVF@10%
PV
0
(1000)
1
(1000)
1
500+700
0.909
1091
NPV
91
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