Abandonment Decisions
Allied Products, Inc., is considering a new product launch. The firm expects to have an annual operating cash flow of $13.5 million for the next 10 years. Allied Products uses a discount rate of 13 percent for new product launches. The initial investment is $59 million. Assume that the project has no salvage value at the end of its economic life.
a. What is the NPV of the new product?
b. After the first year, the project can be dismantled and sold for $37 million. If the estimates of remaining cash flows are revised based on the first year's experience, at what level of expected cash flows does it make sense to abandon the project?