Margerit is reviewing a project with projected sales of 1,500 units a year, a cash flow of $40 a unit and a three-year project life. The initial cost of the project is $95,000. The relevant discount rate is 15 percent. Margerit has the option to abandon the project after one year at which time she feels she could sell the project for $60,000. At what level of sales should she be willing to abandon the project?
A) 899 units
B) 923 units
C) 967 units
D) 1,199 units
E) 1,206 units

Question

Quizplus · Accepted Answer

To determine the level of sales at which Margerit should be willing to abandon the project, we need to compare the present value (PV) of continuing the project for its full term against the PV of abandoning it after one year. 1. Calculate the annual cash flow: 1,500 units * $40 = $60,000.2. Calculate the PV of continuing the project for three years, not including the initial cost, as the question asks for the sales level at which to abandon, implying a focus on operational cash flows:   - Year 1: $60,000 / (1 + 0.15)^1 = $52,173.91   - Year 2: $60,000 / (1 + 0.15)^2 = $45,369.57   - Year 3: $60,000 / (1 + 0.15)^3 = $39,452.23   - Total PV of continuing = $52,173.91 + $45,369.57 + $39,452.23 = $136,995.713. Calculate the PV of abandoning the project after one year:   - Year 1 cash flow PV: $60,000 / (1 + 0.15)^1 = $52,173.91   - Plus the sale of the project: $60,000 / (1 + 0.15)^1 = $52,173.91   - Total PV of abandoning = $52,173.91 + $52,173.91 = $104,347.82Given that the question asks for the sales level at which Margerit should abandon the project, we adjust the calculation to find the break-even point where the PV of continuing equals the PV of abandoning. However, the provided solution directly answers the question without showing these detailed steps for recalculating based on different sales levels. The correct answer (B) 923 units, suggests a calculation that factors in the reduced cash flow that would make the PV of continuing the project equal to the PV of abandoning it. This specific number likely comes from adjusting the annual cash flow ($40 * sales units) and recalculating the PVs to find the point where continuing and abandoning the project have the same value, considering the option to sell the project for $60,000 after one year. The calculation involves finding the sales level that, when multiplied by $40 and then discounted, equals the PV of abandoning the project. The correct sales level for abandonment, based on the provided options, is 923 units, indicating that at this level of sales or lower, the PV of abandoning the project is more favorable or equal to continuing it.

Margerit Is Reviewing a Project with Projected Sales of 1,500