Oklahoma Instruments (OI) Is Considering a Project Called F-200 That

question 6

Multiple Choice

Oklahoma Instruments (OI) is considering a project called F-200 that has an up-front cost of $250,000. The project's subsequent cash flows are critically dependent on whether another of its products, F-100, becomes an industry standard. There is a 50% chance that the F-100 will become the industry standard, in which case the F-200's expected cash flows will be
$110,000 at the end of each of the next 5 years. There is a 50% chance that the F-100 will not become the industry standard, in which case the F-200's expected cash flows will be $25,000 at the end of each of the next 5 years. Assume that the cost of capital is 12%.
-Now assume that one year from now OI will know if the F-100 has become the industry standard. Also assume that after receiving the cash flows at t = 1, OI has the option to abandon the project, in which case it will receive an additional $100,000 at t = 1 but no cash flows after t = 1. Assuming that the cost of capital remains at 12%, what is the estimated value of the abandonment option?

• A) $0
• B) $2,075
• C) $4,067
• D) $8,945
• E) $10,745

---

Definitions:

Commitment

Commitment refers to a pledge or promise to do something, showing dedication to an action, cause, or plan.

Leadership

The action of leading a group of people or an organization, or the ability to do this through vision, guidance, and direction.

Interpretation

The process of explaining or understanding the meaning of something, often applied to texts, laws, or artworks.

Law

A system of rules that a particular country or community recognizes as regulating the actions of its members and may enforce by the imposition of penalties.