Question

Szek Inc. is evaluating a project in that would require a $5900 investment today (t = 0) in S. Dakota. The after-tax cash flows would depend on whether S. Dakota imposes a new property tax. There is a 50-50 chance that the tax will pass, in which case the project will produce after-tax cash flows of $1,350, at the end of each of the next 5 years. If the tax doesn't pass, the after-tax cash flows will be $1,800 for 5 years. The project has a WACC of 8.4%. The firm would have the option to abandon the project 1 year from now, and if it is abandoned, the firm would receive the expected $1350 cash flow at t = 1 and would also sell the property for $5500 at t = 1. If the project is abandoned, the company would receive no further cash inflows from it. What is the value of this abandonment option? What is the value of the project without the abandonment option? (Hint You have to calculate 4 NPVs)

Answer 1