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We are examining a new project. We expect to sell 6,900 units per year at $63 net cash flow apiece for the next 10 years. In other words, the annual cash flow is projected to be $63 × 6,900 = $434,700. The relevant discount rate is 16 percent, and the initial investment required is $1,800,000. After the first year, the project can be dismantled and sold for $1,670,000. Suppose you think it is likely that expected sales will be revised upward to 9,900 units if the first year is a success and revised downward to 5,500 units if the first year is not a success. Suppose the scale of the 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. This implies that if the project is a success, projected sales after expansion will be 19,800. Note that abandonment is still an option if the project is a failure. |
If success and failure are equally likely, what is the NPV of the project? |
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