Question

5. Telsa Enterprises is considering a new project that has a cost of $1,000, and the CFO set up the following simple decision tree to show its three most likely scenarios. Suppose The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so. Then how much is the value of this abandonment option? (4 points) WACC = 11.5% t = 0) Prob. = 20% Prob. = 60% Prob. = 20% Dollars in Thousands t=1 t=2 $800.0 $800.0 $520.0 $520.0 -$200.0 $200.0 -$1,000 t=3 $800.0 $520.0 -$200.0 NPV This Prob. x State NPV $938.10 $187.62 $259.76 $155.86 -$1,484.52 -$296.90 Exp. NPV = $ 46.57

Answer 1

Abandonment value is also known as liquidation value of an asset. The general rule for deciding to discontinue the product is that if the product’s salvage value is greater than the net present value (NPV) of its expected cash flows, the project is abandoned.

Here the salvage value has to be lesser than 46570 dollars and then the project is not abandoned .