Estimate the Mean and Standard Deviation of the NPV of This

question 1

Essay

Estimate the mean and standard deviation of the NPV of this project.Assume that cash flows are discounted at a rate of 10% per year.Now assume that the project has an abandonment option.At the end of each year you can abandon the project for the values given below: For example,suppose that year 1 cash flow is $400.Then,at the end of year 1,you expect cash flow for each remaining year to be $400.This has an NPV of less than $6200,so you should abandon the project and collect $6200 at the end of year 1.Estimate the mean and standard deviation of the project with the abandonment option.How much would you pay for the abandonment option? (Hint: You can abandon a project at most once.Thus,in year 5,for example,you abandon only if the sum of future expected NPVs is less than the year 5 abandonment value and the project has not yet been abandoned.Also,once you abandon the project,the actual cash flows for future years will 0.So,the future cash flows after abandonment should disappear.)

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