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Net Present Value and Abandoning

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We are examining a new project. We expect to sell 750 units at $20 net cash flow apiece for year 1. We expect to sell 250 units in year 2 at $20 net cash flow apiece. The relevant discount rate is 20%, and the initial investment is $55,000.

a) If success and failure are equally likely, what is the NPV of the project? Consider the possibility of abandoning it.

b) What is the value of the option to abandon?

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Solution Summary

This response determines whether a new project is worth investing in or if it is wiser to abandon it.

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Before we consider the possibility of success/failure/abandoning, let's calculate the cash flows and their present value at present

Year 1:
Cash inflow: 750 * $20 = $15,000
Present value = $15,000/(1 + 20%) = $12,500

Year 2:
Cash inflow: 250 * $20 = $5,000
Present value = $5,000/(1 + 20%)^2 = $3,472.22

a) Then we consider all the possible case
Case 1: ...

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