Your firm is considering a project with a five-year life and an initial cost of
ID: 2754881 • Letter: Y
Question
Your firm is considering a project with a five-year life and an initial cost of $130,000. The discount rate for the project is 12%. The firm expects to sell 2,100 units a year. The cash flow per unit is $20. The firm will have the option to abandon this project after three years at which time it expects it could sell the project for $50,000. You are interested in knowing how the project will perform if the sales forecasts for years four and five of the project are revised such that there is a 50% chance that the sales will be either 1,400 or 2,500 units a year. What is the net present value of this project given your sales forecasts?
Explanation / Answer
Answer: The NPV of this project given your sales forecasts is $$18745.9144
Level to abandon=
$50000=(Q*$20)* [[1-[1/(1+0.12)2]/0.12]
=$50000=33.801Q
Q=1479 units
At 1,400 units you will abandon the project and receive $50,000.
At 2,500 you will continue the project and the NPV will be:
NPV=(2500*$20)* [[1-[1/(1+0.12)2]/0.12]
=$50000*0.16901=$84505
Than 50000+84505/2=134505/2=67252,5
NPV=-130000+42000/(1.12)1+42000/(1.12)2+42000/(1.12)3+67252.5/(1.12)3
=-130000+$37500+$33482.1429+29894.7704+47869.0011=$18745.9144
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