Red River Corporation is considering the purchase of new equipment costing $500,000. The expected life of the equipment is 10 years. It is expected that the new equipment can generate an increase in net income of $60,000 per year for the next 10 years. The probabilities for the increase in net income depend on the state of the economy. $\begin{array}{lrrr}
\text { Aftertax}&\text { Aftertax Probabilities}&\text { Net Income }\
\text { Recession } & .5 & (\$ 20,000) \
\text { Normal } & .3 & 40,000 \
\text { Boom } & .2 & 60,000
\end{array}$
The equipment can be amortized using straight-line amortization for tax purposes. Red River's cost of capital is 14%. What is the expected NPV? Should they purchase the new equipment? Would your decision change if the cost of capital was 9%? Why or why not?

Question

Red River Corporation is considering the purchase of new equipment costing $500,000. The expected life of the equipment is 10 years. It is expected that the new equipment can generate an increase in net income of $60,000 per year for the next 10 years. The probabilities for the increase in net income depend on the state of the economy. $\begin{array}{lrrr}
\text { Aftertax}&\text { Aftertax Probabilities}&\text {  Net Income }\
\text { Recession } & .5 & (\$ 20,000) \
\text { Normal } & .3 & 40,000 \
\text { Boom } & .2 & 60,000
\end{array}$
 The equipment can be amortized using straight-line amortization for tax purposes. Red River's cost of capital is 14%. What is the expected NPV? Should they purchase the new equipment? Would your decision change if the cost of capital was 9%? Why or why not?

Quizplus · Accepted Answer

The Answer of Red River Corporation is considering the purchase of new equipment costing $500,000. The expected life of the equipment is 10 years. It is expected that the new equipment can generate an increase in net income of $60,000 per year for the next 10 years. The probabilities for the increase in net income depend on the state of the economy. $\begin{array}{lrrr}
\text { Aftertax}&\text { Aftertax Probabilities}&\text {  Net Income }\
\text { Recession } & .5 & (\$ 20,000) \
\text { Normal } & .3 & 40,000 \
\text { Boom } & .2 & 60,000
\end{array}$
 The equipment can be amortized using straight-line amortization for tax purposes. Red River's cost of capital is 14%. What is the expected NPV? Should they purchase the new equipment? Would your decision change if the cost of capital was 9%? Why or why not?

Red River Corporation Is Considering the Purchase of New Equipment