A machine that costs $1,000,000 is likely to break irreparably with a 20% probability at the end of each year. (Many electric devices without moving parts have such breakdown characteristics.) You can neither replace it nor use it for more than 5 years. The machine can produce $500,000 in profit every year. The discount rate is 12% per annum.

(a) What is the most likely operating time? If this comes true, what is the value?

(b) How long do you expect this machine to operate? (Hint: First work this out case-by-case for a 2-year machine, then for a 3-year machine. Think “D”, “WD”, “WWD”, “WWWD”, and “WWWWD,” where W means working and D means dead.) If it were to last exactly this long, what would be the present value?

(c) Should you purchase this machine?

Answer rating: 100% (QA)

aThe most likely operating time is 3 years If this comes true the value is 1500000 1000000 1 02 3 15... View the full answer