Denver Mart is considering a project with a 5-year life and an initial cost of $120,000.The discount rate is 12 percent.The firm expects to sell 2,100 units a year with a cash flow per unit of $20.The firm will have the option to abandon this project after three years at which time it expects it could sell the project for $50,000.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 50 percent chance that the sales will be 1,400 units and a 50 percent chance 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

NPV = $50,000 = ($20 × Q)[(1 - 1/1.12^{(5 - 3)})/.12]Q = 1,479.25 unitsAt 1,400 units,you will abandon the project at the end of Year 3 and receive $50,000.At 2,500 units,you will continue the project for the last two yearsNPV₃ = (2,500 × $20)[(1 - 1/1.12^{(5 - 3)})/.12] = $84,502.55NPV₀ = -$120,000 + (2,100 × $20)[(1 - 1/1.12³/.12] + [($50,000 + 84,502.55)/2]/1.12³ = $28,745

Denver Mart Is Considering a Project with a 5-Year Life