Question

Golden Corporation is considering the purchase of new equipment costing $200,000. The expected life of the equipment is 10 years. It is expected that the new equipment can generate an increase in net income of $35,000 per year for the next 10 years.

After-tax After tax Probabilities Net Income
Recession .3 (15000)
Normal .5 25000
Boom .2 35000

Golden's cost of capital is 14%. What is the expected NPV? Should they purchase the new equipment?

Answer 1

I must assume that the "2" offered in the "boom" scenario is an error, and that it should be "0.2", because otherwise the sum of probabilities does not equal unity (1) -- which is scientifically impossible, because the set of all possibilities cannot be greater than the aggregate total of all individual probabilities.

Additionally, the hypothetical is impossible, because it unequivocally states that the probability of a "normal" landing is 0.5. If this is true, then the normal landing "is" the expected value, regardless of the other outcomes, and the Recession and boom scenarios are irrelevant to the calculation.

In other words, if the probabily of normal is 50%, and that scenario will produce a $25,000 return, then that scenario MUST be the expected value, otherwise it could not have a 50% probability, because expected value is what occurs at the 50% point on the normal probability distribution curve.

Given the dramatic mathematical problems present in the hypothetical, I will assum that the only relevant values are those found in the "normal" scenario.

Based on the above assumption, Golden's capital cost over 10 years is the future value of borrowing $200,000 at 14% (1.4% per year), or $229,831.50.

Golden's income stream over the same period is $25,000 times 10, or $250,000.

The difference between income and capital cost over 10 years is a profit of $20,168.50.

The NPV of that income stream over the same period, assuming no payments made or income received for the 10 years, is $17,550.69.

Multplying that times the probability of 0.5 gives the "expected value" of $8,775.34.

Answer 2

do u get this?

Answer 3

http://www.justanswer.com/business-law/1steh-golden-corporation-considering-purchase-new-equipment.html This willl help u! It explains how to do it, and gives u the answers! I hope this helps:)

Answer 4

go to the link above and i think you will figure it out

Answer 5

okay