Estimate the Mean and Standard Deviation of the NPV of This

question 17

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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Definitions:

Monogamy

A relationship or marriage system where an individual has only one partner at a time.

Christian Names

Traditionally, given names selected from the Bible or derived from saints and other Christian religious figures, commonly used in Christian families.

Popé

A Pueblo religious leader who orchestrated the Pueblo Revolt against Spanish colonial rule in New Mexico in 1680.

Friars

Members of certain religious communities of men, especially of the four mendicant orders (Dominican, Franciscan, Carmelite, and Augustinian).