We are examining a new project. We expect to sell 7,100 units per year at $56 net

Question:

We are examining a new project. We expect to sell 7,100 units per year at $56 net cash flow apiece for the next 10 years. In other words, the annual cash flow is projected to be $56 × 7,100 = $397,600. The relevant discount rate is 14 percent, and the initial investment required is $1,800,000.

a. What is the base-case NPV?

b. After the first year, the project can be dismantled and sold for $1,200,000. If expected sales are revised based on the first year’s performance, when would it make sense to abandon the investment? In other words, at what level of expected sales would it make sense to abandon the project?

c. Explain how the $1,200,000 abandonment value can be viewed as the opportunity cost of keeping the project in one year.

Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal... Opportunity Cost
Opportunity cost is the profit lost when one alternative is selected over another. The Opportunity Cost refers to the expected returns from the second best alternative use of resources that are foregone due to the scarcity of resources such as land,...

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