Problem 3

There is an opportunity to acquire well-servicing equipment for $600,000. There is a 15 %

probability that after acquiring the equipment we decide to NOT pursue the well-servicing

business. In this case, we could sell the equipment next year for $500,000. If we go into the well-

servicing business, we anticipate annual after-tax revenues of $300,000 for 5 years, starting next

year. There is a 35 % probability that we enter the business and have to overhaul and upgrade

some of the equipment in 2 years. This would reduce after-tax cash flow by $200,000 in Year 2.

Should we purchase the equipment? We are currently earning 20% on other investment

opportunities.