By acquiring a machine, ABC can invest in a project that will yield $55,000 at the...

 

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By acquiring a machine, ABC can invest in a project that will yield $55,000 at the end of the year. The machine does not depreciate and has a residual value of $110,000 at the end of the year. At time 0 (now), ABC can either raise equity capital to buy the machine for $110,000 or lease it for $10,000. The risk-free rate is 10%. Suppose there is a 30% risk-neutral probability that ABC will be bankrupt and equityholders will be wiped out. Should ABC buy or lease the machine? You must show your workings clearly to get credit. By acquiring a machine, ABC can invest in a project that will yield $55,000 at the end of the year. The machine does not depreciate and has a residual value of $110,000 at the end of the year. At time 0 (now), ABC can either raise equity capital to buy the machine for $110,000 or lease it for $10,000. The risk-free rate is 10%. Suppose there is a 30% risk-neutral probability that ABC will be bankrupt and equityholders will be wiped out. Should ABC buy or lease the machine? You must show your workings clearly to get credit.

Answer rating: 100% (QA)

SOLUTION To determine whether ABC should buy or lease the machine we need to compare the net present ... View the full answer