Carlson Inc.is evaluating a project in India that would require a $5.8 million investment today (t = 0).The after-tax cash flows would depend on whether India imposes a new property tax.There is a 50-50 chance that the tax will pass,in which case the project will produce after-tax cash flows of $1,350,000 at the end of each of the next 5 years.If the tax doesn't pass,the after-tax cash flows will be $1,800,000 for 5 years.The project has a WACC of 10.4%.The firm would have the option to abandon the project 1 year from now,and if it is abandoned,the firm would receive the expected $1.35 million cash flow at t = 1 and would also sell the property for $4.45 million at t = 1.If the project is abandoned,the company would receive no further cash inflows from it.What is the value (in thousands)of this abandonment option? Do not round intermediate calculations.
A) $99
B) $70
C) $94
D) $108
E) $89

Question

Quizplus · Accepted Answer

? 11ea856c_8b88_29c9_9aec_d33db4556dc6_TB1222_00 ? 11ea856c_8b88_50da_9aec_59b239d86f98_TB1222_00 The value of the abandonment option is the difference between the expected value of the project with and without the abandonment option.However,if the NPV of the project without the option is negative,then the value of the option is simply the NPV of the project with the option (because the project wouldn't be undertaken otherwise).Option value = NPV with option ? NPV w/o option = $94