Question

Conditional Ltd. operates under ideal conditions of uncertainty. It has just purchased a new machine, at a cost of $ 3,575.10, paid for entirely from the proceeds of a stock issue. The interest rate in the economy is 8%. The machine is expected to last for two years, after which time it will have zero salvage value. The new machine is an experimental model, and its suitability for use in Conditional’s operations is not completely known. Conditional assesses a 0.75 probability that there will be a major machine failure during the first year of operation, and a 0.25 probability that the machine will operate as planned. If there is a major failure, cash flow for the year will be $ 1,000. If the machine operates as planned, cash flow will be $ 3,000 for the year. If there is no major failure in the first year, the probability of a major failure in the second year, and resulting cash flows of $ 1,000, falls to 0.60. If there is no major failure in the second year, cash flows for that year will again be $ 3,000. However, if there is a major failure in the first year, the lessons learned from correcting it will result in only a 0.10 probability of failure in the second year. It turns out that there is no major failure in the first year.

Required
a. Verify that the cost of $ 3,575.10 for the machine is correct.
b. Prepare an income statement for year 1.
c. Prepare a balance sheet at the end of the first year.



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  • CreatedSeptember 09, 2014
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