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

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?

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