Corporate Finance

Class Assignment

Topic: Options Applications in Corporate Finance

Date: May 13, 2021

Company Z is examining a new project. It expects to sell 7,500 units per year at $68
cash flow a piece for the next 10 years. The relevant discount rate is 14 percent and the
initial investment required is $2.3 million.

a. What is the base-case NPV?

b. After the first year, the project can be dismantled and sold for $1.5
million. If the expected sales are revised based on first year’s
performance, when would it make sense to abandon the project? In
other words, at what level of expected sales would it make sense to
abandon the project?
c. Suppose you think it is likely that the expected sales will be revised
upwards to 9,500 units if the first year is a success and revised
downward to 4,000 units if the first year is not a success. If success
and failure are equally likely, what is the NPV of the project? What is
the value of abandonment option?
d. Suppose the scale of project can be doubled in one year in the sense
that twice as many units can be produced and sold. Naturally,
expansion would be desirable only if the project is a success.
Abandonment is still an option if the project is a failure. What is the
value of expansion option?