A firm has estimated the NPV of a new product release as -$100,000.However,if the product is a failure,the firm estimates it can sell off the equipment to help cash flow.An analyst estimates the value of abandoning the product release at $125,000.The cost of capital for the firm is 10%.What is the project value for the firm?

Question

Quizplus · Accepted Answer

The project value formula is:
Project Value = NPV + Abandonment Option Value

NPV = -$100,000
Abandonment Option Value = $125,000

Discounting the abandonment option value at 10%, we get:
Abandonment Option Value = $125,000 / (1 + 10%) = $113,636.36

Therefore,
Project Value = -$100,000 + $113,636.36
Project Value = $13,636.36

The best choice is C, as it is the only option that represents a positive project value, meaning that the project is expected to create value for the firm.

A Firm Has Estimated the NPV of a New Product