Denver Mart is considering a project with a life of 5 years and an initial cost of $136,000.The discount rate is 11 percent.The firm expects to sell 2,200 units a year with a cash flow per unit of $26.The firm will have the option to abandon this project after 3 years at which time it expects it could sell the project for $48,000.The firm is interested in knowing how the project will perform if the sales forecast for Years 4 and 5 of the project are revised such that there is a probability of 50 percent that the sales will be 1,000 units and a probability of 50 percent they will be 2,500 units a year.What is the net present value of this project given your sales forecasts?

Question

Quizplus · Accepted Answer

$48,000 = ($26 × Q)[(1 - 1 / 1.11^5-3)/ 0.11] Q = 1,078.03 units At 1,000 units,you will abandon the project at the end of Year 3 and receive $48,000. At 2,500 units,you will continue the project for the last two years. NPV₃ = (2,500 × $26)[(1 - 1 / 1.11^5-3)/ 0.11] = $111,314.02 NPV₀= -$136,000 + (2,200 × $26)[(1 - 1 / 1.11³)/ 0.11] + [($48,000 + $111,314.02)/ 2] / 1.11³ NPV₀= $62,025

Denver Mart Is Considering a Project with a Life of 5