Accounting for Decision Making and Control 6th Edition by Jerold Zimmerman

Exercise 30

Weil Inc. is examining a new project. Weil expects to sell 500 units per year at $20 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to be $20 X 500 = $10,000 per year. The relevant discount rate is 20 percent, and the initial investment is $45,000.
Required:
a. What is the net present value
b. Assume now that after the first year, the project can be dismantled and sold for $40,000.
If the expected number of units sold in each of the remaining nine years is revised to equal the number of units sold in the first year, at what level of first-year sales would it make sense to abandon the project
c. Now suppose that there are only two possible sales levels: 750 units and 250 units. If 750 units are sold in the first year, sales in years 2 through 10 will be 750 units. If 250 units are sold in the first year, sales in future years will be 250 units. If the two sales levels in year 1 are equally likely, what is the NPV of the project Consider the possibility of abandonment (at a salvage value of $40,000) in answering the question.
d. What is the value of the option to abandon in (c)