Look again at practice question 10. We will assume that Technology A has a salvage value of

Question:

Look again at practice question 10. We will assume that Technology A has a salvage value of $7 million, rather than zero. The present value of the project with Technology A is $11.5 million at year 0, assuming no abandonment. The risk-free rate is 7 percent.

(a) Construct a one-year binomial tree for this project, with one up or down step every three months (four steps total). The up steps are +25 percent, the down steps are – 16.7 percent.

(b) Suppose abandonment can only occur at year 1. In what circumstances would you abandon then? What is abandonment value at year 0?

Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important...