What is the value of the abandonment option

Assignment Help Finance Basics

Reference no: EM131546543

CASE 21 QUESTIONS: NATIONAL REHABILITATION CENTERS

Staged Entry Analysis

1. Consider the R&D expenses.
a. Why aren't these expenses classified as "sunk costs?"
b. Explain why the R&D expenses are solely a time value of money issue.

2. Assume that the Stage 1 project has average risk as compared to the company's current business line. What is Stage 1's freestanding expected NPV? Based on your financial analysis thus far, is Proposal B acceptable?

3. Now consider the expansion (Stage 2) project.

a. What is the NPV of Stage 2 at the end of Year 0 under each demand scenario?
b. What is Stage 2's expected NPV at the end of Year 0? Again, assume that Stage 2 has average risk.
c. For ease of analysis, Stage 2 has been treated as if it could be undertaken independently.
Is this a realistic assumption? Does the stand-alone profitability of Stage 2 have any value in the decision process?

4. Now combine the two stages into a single project. Construct a decision tree to help in the analysis. What is the overall expected NPV of Proposal B?

5. Use the decision tree data to find Proposal B's standard deviation and coefficient of variation of NPV. Should Proposal B be classified as a high-, average-, or low-risk project? (For now, disregard the abandonment option.)

6. What is Proposal B's differential risk-adjusted NPV? (Again, disregard the abandonment option.)

7. Now consider the impact of abandonment at the end of Year 8.

a. What impact does the abandonment option have on the overall project's risk and return? (Hint: Return to the 10 percent unadjusted discount rate.)
b. What is the value of the abandonment option?

8. a. What type of risk was measured in the analysis? Is this appropriate? If not, how could you measure the relevant risk of the project?
b. In the analysis, you probably applied a single differential risk-adjusted discount rate to all cash flows, that is, to the cash flows of both stages. Does this make sense?

9. Describe the advantages and disadvantages of Proposal A (single, large investment) versus Proposal B (staged entry). Based on the limited amount of information available, what do you think the company should do? Carefully justify your final recommendations.

10. In your opinion, what are three key learning points from this case?

Attachment:- Case-Reading.rar

Reference no: EM131546543

Questions Cloud

Difference between weak-field and strong-field metal complex : Why does silicon form only single bonds with oxygen but carbon, which is in the same family as silicon, form double bonds with oxygen in many compounds?

Discuss the four p of marketing : What are the four P's of marketing and how are they applied to marketing APN practice?

How is rheumatoid different than osteoarthritis : What is TMJ. Why is it prone to problems and how is it treated? How is rheumatoid different than osteoarthritis?

Thinking like a mountain by aldo leopold : A deep chesty bawl echoes from rimrock to rimrock, rolls down the mountain, and fades into the far blackness of the night.

What is the value of the abandonment option : What is the value of the abandonment option? What is Proposal B's differential risk-adjusted NPV? (Again, disregard the abandonment option.)

Create a resume detailing your license and earned degree : Write an introductory Cover Letter of no more than 500 words in which you explain your Professional Objectives, Professional Interests, and Strengths.

What would the monthly payment be for this mortgage : What would the monthly payment be for this mortgage? Calculate the total amount of interest paid throughout the life of the loan.

Explain the socio-cultural barriers : Do your research and explain the socio-cultural barriers faced by these two companies, pepsi & coke - What in your view were the reasons.

What type of demeanor is expected? : What type of demeanor is expected? Are there body language expectations?What are the main ethics rules of the profession?

User Account

All Pages