a. SI is considering investing in a new product named Z-90. There is a 50% chanc

Question

a.       SI is considering investing in a new product named Z-90. There is a 50% chance that the product will be a success which then generates $110,000 cash inflow each year for the next 5 years. There is a 50% chance that the product will fail which then generates $25,000 cash inflow each year for the next 5 years. The project requires an initial investment of $250,000. Based on the above information, what is the Z-90's expected net present value?

b.      Now assume that one year from now SI will know if the Z-45 has become the industry standard. Also assume that after receiving the cash flows at t = 1, SI has the option to abandon the project, in which case it will receive an additional $100,000 at t = 1 but no cash flows after t = 1. Assuming that the cost of capital remains at 12%, what is the estimated value of the abandonment option?

Explanation / Answer

inflow= 50%*110000+50%*25000=67500

present value=67500*3.604=243270

NPV=243270-250000=-6730

B.abandonment value=167500*0.893=149577.5

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