Problem: Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 10 units per year at $0.3 million net cash flow per unit for the next five years. The engineering department has come up with the estimate that developing the machine will take $10 million initial investment. The finance department has estimated that 25 percent discount rate should be used.
1. What is the base case NPV?
2. If unsuccessful, after the first year the project can be dismantled and sold for scrap for $5 million. Also, after the first year, expected cash flows will be revised up to 20 units per year or to 0 units, with equal probability. If so, what is the option value of abandonment? What is the revised NPV?