Steppingstone Incorporated

The Z90 project being considered by Steppingstone Incorporated (SI) has an up-front cost of $250,000. The project's subsequent cash flows are critically dependent on whether another of its products, Z45, becomes an industry standard. There is a 50% chance that the Z45 will become the industry standard, in which case the Z90's expected cash flows will be $110,000 at the end of each of the next 5 years. There is a 50% chance that the Z45 will not become the industry standard, in which case the Z90's expected cash flows will be $25,000 at the end of each of the next 5 years. Assume that the cost of capital is 12%.

Refer to data for Steppingstone Incorporated (SI). Now assume that one year from now SI will know if the Z45 has become the industry standard. Also assume that after receiving the cash flows at t = 1, SI has the option to abandon the project, in which case it will receive an additional $100,000 at t = 1 but no cash flows after t = 1. Assuming that the cost of capital remains at 12%, what is the estimated value of the abandonment option?

a. $2,075

b. $0

c. $4,067

d. $10,745

e. $8,945