Question

Albert Co. is considering a four-year project that will require an initial investment of $5,000. The base-case cash flows for this project are projected to be $15,000 per year. The best-case cash flows are projected to be $22,000 per year, and the worst-case cash flows are projected to be -$1,500 per year. The company's analysts have estimated that there is a 50% probability that the project will generate the base-case cash flows. The analysts also think that there is a 25% probability of the project generating the best-case cash flows and a 25% probability of the project generating the worst-case cash flows. What would be the expected net present value (NPV) of this project if the project's cost of capital is 13%? $39,064 O $35,808 O $29,298 O $32,553 Albert now wants to take into account its ability to abandon the project at the end of year 2 if the project ends up generating the worst-case scenario cash flows. If it decides to abandon the project at the end of year 2, the company will receive a one-time net cash inflow of $3,000 (at the end of year 2). The $3,000 the company receives at the end of year 2 is the difference between the cash the company receives from selling off the project's assets and the company's -$1,500 cash outflow from operations. Additionally, if it abandons the project, the company will have no cash flows in years 3 and 4 of the project. Using the information in the preceding problem, find the expected NPV of this project when taking the abandonment option into account. O $33,924 $44,101 $40,709 $35,620

Answer 1

Answer-

1.

Calculation of Average cash flows-

Cash Flows	Probability	Average Cash Flow
$15,000	50%	$7,500
$22,000	25%	$5,500
-$1,500	25%	-$375
Average Cash Flow		$12,625

Calculation of NPV-

Year	Cash Flow	Discounting Factor@13%	Present Value
0	-$5,000	1	-$5,000
1	$12,625	0.884955752	$11,172.57
2	$12,625	0.783146683	$9,887.227
3	$12,625	0.693050162	$8,749.758
4	$12,625	0.613318728	$7,743.149
		NPV	$32,552.70

2.

Case-2-If project ends up generating worst cash flows

Calculation of NPV

Year	Cash Flow	Discounting Factor@13%	Present Value
0	-$5,000	1	-$5,000
1	-$1,500	0.884955752	-$1,327.43
2	$3,000	0.783146683	$2,349.44
3	$0	0.693050162	$0
4	$0	0.613318728	$0
		NPV	-$3,977.99