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%)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?

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 with the PV of abandoning it after one year. 1. The cash flow from continuing the project for one more year is €40 per unit. 2. The discount rate is 15%.3. The salvage value if abandoned after one year is €60,000.The formula for the present value of continuing the project for one more year is:$$ PV = \text{Cash Flow per Unit} \times \text{Number of Units} \times \frac{1}{(1 + \text{Discount Rate})} $$The present value of abandoning the project is simply the salvage value discounted back one year:$$ PV_{\text{abandon}} = \frac{\text{Salvage Value}}{(1 + \text{Discount Rate})} = \frac{60,000}{1.15} $$Setting these equal to solve for the number of units at which Margerit is indifferent to continuing or abandoning:$$ 40 \times \text{Units} \times \frac{1}{1.15} = \frac{60,000}{1.15} $$Solving for units gives us the break-even point for her decision. Given the choices, the correct calculation aligns with option B, which suggests that at 923 units, the present value of continuing equals the present value of abandoning, making it the threshold for her decision.

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