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Liberty Products, Inc., is considering a new product launch. The firm expects to have annual free...

Liberty Products, Inc., is considering a new product launch. The firm expects to have annual free cash flow of $5.3 million for the next eight years. The company uses a discount rate of 11% for new product launches. The initial investment is $23 million. Assume that the project has no salvage value at the end of its economic life. After the first year, the project can be dismantled and sold for $18 million after taxes.

a. Ignoring the option to abandon, what is the NPV of this project?

b. Suppose it is likely that expected annual free cash flow will be revised upward to $7.3 million if the first year is a success and revised downward to $3.3 million if the first year is not a success. If success and failure are equally likely, what is the NPV of the project when the option of abandonment is considered? What is the value of the option to abandon?

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