A Mountain Sports, Inc. can undertake a new product line of rock climbing equipment that calls...

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A" Mountain Sports, Inc. can undertake a new product line of rock climbing equipment that calls for an investment of $20 million today. There are two possible outcomes from undertaking this project: Under the "High" state, which occurs with a 3/4 probability, the after-tax operating cash flows (including all depreciation and taxes) from the new product line will be $5 million a year for 10 years beginning one year from today. Under the "Low" state, which occurs with a 1/4 probability, the after-tax operating cash flows (including all depreciation and taxes) from the new product line will be $1 million a year for 10 years beginning one year from today. The company has the option to abandon the project one year from today after receiving the first cash flow and determining if the product line is a success (in a "High" state) or not ("Low" state) from that point forward. If the company abandons the product line at the end of the first year (after receiving the 1 million cash flow for the first year), it can sell the licenses and other materials associated with the new product line for an additional $11 million, which reflects the net proceeds from the sale after tax adjustments for loss or gain on sale. In other words, if you abandon the project, you would receive 1 + 11 = 12 million one year from today but no additional cash flows after that time. Assuming a discount rate of 16%, answer the following questions: What is the NPV of the project with the option to abandon? A" Mountain Sports, Inc. can undertake a new product line of rock climbing equipment that calls for an investment of $20 million today. There are two possible outcomes from undertaking this project: Under the "High" state, which occurs with a 3/4 probability, the after-tax operating cash flows (including all depreciation and taxes) from the new product line will be $5 million a year for 10 years beginning one year from today. Under the "Low" state, which occurs with a 1/4 probability, the after-tax operating cash flows (including all depreciation and taxes) from the new product line will be $1 million a year for 10 years beginning one year from today. The company has the option to abandon the project one year from today after receiving the first cash flow and determining if the product line is a success (in a "High" state) or not ("Low" state) from that point forward. If the company abandons the product line at the end of the first year (after receiving the 1 million cash flow for the first year), it can sell the licenses and other materials associated with the new product line for an additional $11 million, which reflects the net proceeds from the sale after tax adjustments for loss or gain on sale. In other words, if you abandon the project, you would receive 1 + 11 = 12 million one year from today but no additional cash flows after that time. Assuming a discount rate of 16%, answer the following questions: What is the NPV of the project with the option to abandon?

Answer rating: 100% (QA)

Probability of High state 34 Probability of Low state 14 If High state Cash flows ... View the full answer