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Homework answers / question archive / Acct 352 Merritt Company is considering a new project that has a cost of $1,000,000
Acct 352 Merritt Company is considering a new project that has a cost of $1,000,000. The CFO gathered the following information for the three most likely scenarios. Merritt could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to obtain this abandonment option, Merritt would have to make a payment to those parties. (Note: The appropriate cost of capital is 11.5%.)
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---------------Dollars in Thousands--------------- |
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t = 0 |
t = 1 |
t = 2 |
t = 3 |
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Prob = |
25% |
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$800.0 |
$800.0 |
$800.0 |
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Prob = |
50% |
-$1,000 |
$520.0 |
$520.0 |
$520.0 |
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Prob = |
25% |
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-$200.0 |
-$200.0 |
-$200.0 |
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Required:
Calculate the expected NPV of the project under the conditions of (i) choosing not to abandon, or (ii) choosing to abandon at the end of Year 1. How much is the option to abandon worth (in thousands) to Merritt?
