James is performing an analysis on the overall NPV of the firm's project with the option to
Question:
James is performing an analysis on the overall NPV of the firm's project with the option to abandon. The project costs $4,000 to set up and generates an annual cash flow of $1,000 for the next 20 years.
After 3 years, the estimate of remaining annual cash flows will be revised either upward to $1,500 or downward to $400. The upward revision is expected to happen with probability of 40% and the downward revision is expected to happen with probability of 60%. At that time, this project can be sold for $5,000.
Calculate the revised NPV given that the firm have the option to abandon the project after 3 years? The discount rate is 12% and cash flows occur at year-end.
Introduction to Operations Research
ISBN: 978-1259162985
10th edition
Authors: Frederick S. Hillier, Gerald J. Lieberman