Red River Corporation Is Considering the Purchase of New Equipment

question 18

Essay

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.
After tax
$\begin{array}{llr}&\text { After tax Probabilities }&\text { Net Income }\\\text { Recession } & .5 & (\$ 20,000) \\\text { Normal } & .3 & 40,000 \\\text { Boom } & .2 & 60,000\end{array}$ 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?

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Definitions:

Hydrothermal Vents

Openings in the seafloor that emit hot, mineral-rich water, supporting unique ecosystems despite the extreme conditions.

Drill Cores

Cylindrical sections of rock extracted from the Earth by drilling, often used for geological research and analysis.

Black Smokers

Hydrothermal vents on the ocean floor that emit dark clouds of mineral-rich water, typically found along mid-ocean ridges.

Radioactive Decay

The process by which an unstable atomic nucleus loses energy by emitting radiation in the form of particles or electromagnetic waves.