Peterson Trucking is contemplating the acquisition of Armour Transport, a competing trucking firm, and estimates that during the next year Armour Transport’s flows from the acquisition will vary depending upon the state of the local economy:
a. Calculate the expected cash flow for next year using the estimates provided above.
b. Assume the probability of a recession increases to 40 percent, the normal scenario probability remains at 50 percent, and the expansion probability drops to only 10 percent. What is your estimate of the expected cash flow for next year under this circumstance?
c. Your analysis of the acquisition suggests that for the investment to have at least a zero NPV, it must produce an annual expected cash flow of $100,000 per year over the next five years. Assuming that the cash flow you estimated in part a is the expected cash flow for Years 1 through 5, what would you like to know about the project cash flows to make you more comfortable with the idea that you can indeed generate the requisite $100,000 per year cash flow? (No computations required.)