Question: ABC Corp is planning to purchase a machine. The initial cost of the machine is $1 million. The net present value of cash flows from

ABC Corp is planning to purchase a machine. The initial cost of the machine is $1 million. The net present

value of cash flows from the machine is expected to be $1.3 million today for the next 20 years. The

volatility of the future cash flows is 15% per year. After 20 years, the value of selling the machine is $0.

The manufacturer of the machine also offers an option that ABC Corp can sell the machine back to the

manufacturer after 15 years at $0.75 million. The cost of the option now is $1,000. The risk-free rate is 5%

per year.

Should ABC Corp buy the option or not?

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