Question

Western Industrial Products is considering a project with a four-year life and an initial cost of $268,000. The discount rate for the project is 14.5 percent. The firm expects to sell 2,200 units on the last day of each year. The cash flow per unit is $50. The firm will have the option to abandon this project after one year at which time the project's assets could be sold for an estimated $225,000. The firm should abandon the project immediately following the sale on the last day of the first year if the expected level of annual sales, starting with year 2, falls to _____ units or less. Ignore taxes.

1,955 units

1,667 units

1,922 units

2,034 units

2,108 units

Answer 1

The correct choice is 1667 units.

If the sales level is 1667 units, NPV of the project at end of year 1 = - $268,000 + ($ 50 x 1667)   1.145¹ + $ 225,000   1.145¹

NPV of project at sales level of 1667 units = $ 1,301.31

The firm should abandon the project immediately if the expected level of annual sales, starting with year 2, falls to 1667 units or less.