Your firm is considering a project with a five-year life and an initial cost of

Question

Your firm is considering a project with a five-year life and an initial cost of $120,000. The discount rate
for the project is 12%. The firm expects to sell 2,100 units a year. The cash flow per unit is $20. The firm
will have the option to abandon this project after three years at which time it expects it could sell the
project for $50,000. You are interested in knowing how the project will perform if the sales forecasts for
years four and five of the project are revised such that there is a 50% chance that the sales will be either
1,400 or 2,500 units a year. What is the net present value of this project given your sales forecasts?
A. $23,617
B. $23,719
C. $25,002
D. $26,877
E. $28,746

Please show me the steps.

Explanation / Answer

Expected sales units for year 4 and 5 = 1400*.5 + 2500 *.5 = 1950

NPV = -120000 + (2100*20)/1.12 + (2100*20)/1.12^2 + (2100*20)/1.12^3 + (50000*0.5)/1.12^3 + (2500*0.5*20)/1.12^4 +(2500*0.5*20)/1.12^5

= 28745

Correct option:

E. $28,746

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