An Abandonment Option Will Have an Upfront Cost of $1

question 36

Multiple Choice

An abandonment option will have an upfront cost of $1.0 million.  There is a 40% chance that the abandonment option would be used, in which case cash outflows of $800,000 in Year 4, $1,400,000 in Year 5 and $1,200,000 in Year 6 will be avoided.  If the discount rate is 7.0%, should the abandonment option be exercised?

• A)Yes because its impact on expected NPV about $101,000.
• B)No because its impact on expected NPV is about ($37,000).
• C)Yes because its impact on expected NPV is about $47, 600.
• D)No because its impact on expected NPV is about ($23,700).

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Definitions:

Long-Term Debt

Financial obligations of a company that are due more than one year in the future.

Current Assets

Assets owned by a company that are expected to be converted into cash, sold, or consumed within one year or within the operating cycle of the business.

Present Value

The current value of a future sum of money or stream of cash flows given a specified rate of return, used in discounting to determine investment worth.

Long-Term Liabilities

Financial obligations of a company that are due after more than one year.