Question

Western Industrial Products is considering a project with a five-year life and an initial cost of $320,000. The discount rate for the project is 9 percent. The firm expects to sell 2,800 units a year. The cash flow per unit is $40. The firm will have the option to abandon this project at the end of year three (after year three's sales) at which time the project's assets could be sold for an estimated $65,000. The firm should abandon the project at the end of year three if the expected level of annual sales, starting with year 4, falls to _____ units or less. Ignore taxes.

	933 units
	1,400 units
	79 units
	924 units
	1,931 units

Answer 1

Present value of salvage value of the project if abondonned in the 3rd year

= $ 65000*PVF(9%,3)

= $ 65000*0.77218

= $ 50191

If the value of the future cash inflows is more than this,then it is good to continue the project

By going with the options

Units	Cash flow per unit	Total cash flow	PVF ( 9%,4)	Discounted value
933	$40	$37,320	0.7084	$26,438.43
1400	$40	$56,000	0.7084	$39,671.81
79	$40	$3,160	0.7084	$2,238.62
924	$40	$36,960	0.7084	$26,183.40
1931	$40	$77,240	0.7084	$54,718.76

If the sale is 1931 units its present value $ 54718 is greater than PV of abandon value of projet($ 50191)

So we can see from the above table is that when 1400 units are sold its present value is less than the abondon value of the project

So when the sales falls to 1400 units or less we can abandon the project