Problem $7-19$ Abandonment and Expansion

We are examining a new project. We expect to sell $6,500$ units per year at $$59$ net cash

flow apiece for the next $10$ years. In other words, the annual operating cash flow is

projected to be $$596,500=$$$383,500.$ The relevant discount rate is $13$ percent, and

the initial investment required is $$1,760,000.$ After the first year, the project can be

dismantled and sold for $$1,630,000.$ Suppose you think it is likely that expected sales will

be revised upward to $9,500$ units if the first year is a success and revised downward to

$5,100$ units if the first year is not a success. Suppose the scale of the project can be

doubled in one year in the sense that twice as many units can be produced and sold.

Naturally, expansion would be desirable only if the project were a success. This implies

that if the project is a success, projected sales after expansion will be $19,000.$ Note that

abandonment is an option if the project is a failure.

a$.$ If success and failure are equally likely, what is the NPV of the project? $($Do not round

intermediate calculations and round your answer to $2$ decimal places, e$.$g$.,32\mathrm{.}16.)$

b$.$ What is the value of the option to expand? $($Do not round intermediate calculations

and round your answer to $2$ decimal places, e$.$g$.,32\mathrm{.}16.)$

a$.$ NPV

b$.$ Option value