You are planning to produce a new action figure called "Hillary".However,you are very uncertain about the demand for the product.If it is a hit,you will have net cash flows of $50 million per year for three years (starting next year,i.e.,at t = 1).If it fails,you will only have net cash flows of $10 million per year for two years (also starting next year).There is an equal chance that it will be a hit or failure (probability = 50%).You will not know whether it is a hit or a failure until the first year's cash flows are in,i.e.,at t = 1.You have to spend $80 million immediately for equipment and the rights to produce the figure.If you can sell your equipment for $60 million immediately after the first year's cash flows are received,calculate Hillary's NPV with this abandonment option.(The discount rate is 10%.The equipment can only be resold at the end of the first year.)
A)-9.1
B)+9.1
C)+13.99
D)-14.4

Question

Quizplus · Accepted Answer

The NPV with the abandonment option is calculated by considering the option to sell the equipment after the first year if the project is a failure. The expected NPV is the weighted average of the NPV if it's a hit and the NPV if it's a failure with abandonment. The correct NPV is +13.99.

You Are Planning to Produce a New Action Figure Called