You are also considering another project which has a physical life of 3 years; that is, the machinery will be totally worn out after 3 years. However, if the project were terminated prior to the end of 3 years, the machinery would have a positive salvage value. Here are the project’s estimated cash flows:

Initial Investment    End-of-Year

And Operating       Net Salvage

Year                          Cash Flows                          Value

0                                 ($8,000)                           $8,000

1                                    3,900                                5,100

2                                    3,000                                2,500

3                                    2,550                                       0

Using the 8% cost of capital, what is the project’s NPV if it is operated for the full 3 years?

Would the NPV change if the company planned to terminate the project at the end of Year 2? At the end of Year 1?

What is the project’s optimal (economic) life?