Merritt Company Is Considering a New Project That Has a Cost

question 23

Multiple Choice

Merritt Company is considering a new project that has a cost of $1,000,000,and the CFO set up the following simple decision tree to show its three most likely scenarios.Merritt could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so,but to obtain this abandonment option,Merritt would have to make a payment to those parties.How much is the option to abandon worth (in thousands) to Merritt? $\begin{array}{l}\begin{array}{lll}\mathrm{WACC}=11.5 \%& \text { Dollars in Thousands }\\&t=10\\\hline \text { Prob }=25 \% & \\\text { Prob }=50 \% & -\$ 1,000 \\\text { Prob }=25 \%\end{array}\begin{array}{lll} \text { NPV this } &\text { Prob } \times\\t=1 & t=2 & t=3 & \text { State } & \text { NPV } \\\hline \$ 800.0 & \$ 800.0 & \$ 800.0 & \$ 938.1 & \$ 234.5 \\\$ 520.0 & \$ 520.0 & \$ 520.0 & \$ 259.8 & \$ 129.9 \\-\$ 200.0 & -\$ 200.0 & -200.0 & -\$ 1,484.5&-\$ 371.1\end{array}\end{array}$

$\begin{array}{r}\text { Exp }-\$ 6.7 \\\text { NPV }\end{array}$

• A)$68.8
• B)$72.5
• C)$76.3
• D)$80.1

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Definitions:

Entry Barriers

Factors that prevent or hinder companies from entering a particular market, including high start-up costs, stringent regulations, and established competitors.

Competitive Forces

Elements in the external environment that influence the competitiveness of a company, including rivalry among existing competitors, threat of new entrants, threat of substitute products, bargaining power of buyers, and bargaining power of suppliers.

Economic Profit

The difference between total revenue and total costs, including both explicit and implicit costs, indicating the profitability of an enterprise beyond basic financial profit.

Monopoly

A market structure characterized by a single supplier controlling all the supply of a particular good or service.