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A product producing plans to purchase for $100,000 a new piece of equipment having an expected useful life of 5 years.
A product producing plans to purchase for $100,000 a new piece of equipment having an expected useful life of 5 years. Based on past experience of similar equipment, the purchasing manager estimates that the salvage value of this equipment, if utilized under regular demand condition, has a probability of 60% of being $10,000 and a probability of 40% of being $12,000. If the demand condition is high, then the equipment will be over-utilized and the salvage value will be $1,000. If the demand is low, the equipment will be under-utilized and the salvage value will be $20,000 (all the figures are after tax and in constant dollar). The likelihood of different market condition and the associated net annual cash flow is provided in the following table.
