A company incurred a cost of $600,000 a year ago to acquire the development righ

Question

A company incurred a cost of $600,000 a year ago to acquire the development rights to a property for which an offer of $1 million cash has been received now at time 0. The acquisition cost will be written-off against the sale value if sold at time 0, or assume it has been amortized over the production years 1 through 5 in calculating the after-tax cash flows given. Any gain from the sale would be taxed as ordinary income at the effective tax rate of 40%. Development of the property would generate escalated dollar after-tax cash flow in million dollars of -1.75 in year 0, and +1.1, +1.7, +1.5, +0.6, and +0.5 in years 1 through 5, respectively. If the minimum escalated dollar DCFROR is 18%, should the company keep and develop the property or sell if there is considered to be a 60% probability of development generating positive cash flow in the year 1 through 5, and 40% probability of failure generating zero cash flow in year 1 through 5? What development probability of success will make the economics of development a break-even with selling?

A)Develop;Probability=0.71
B)Develop;Probability=0.59
C)Sell;Probability=0.71
D) Sell; Probability=0.59

Explanation / Answer

a.develop;probability=0.71

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