Suppose you are the manager of a small manufacturing company. You are trying to decide whether to purchase a new machine for your production line. The machine costs $100,000 and has a useful life of 5 years. It will increase your production capacity and reduce your labor costs. You estimate that the machine will generate additional revenues of $50,000 per year for the next 5 years, and it will reduce your labor costs by $20,000 per year for the next 5 years. After 5 years, the machine will have no salvage value.

You estimate that the probability of success of the investment will depend on two factors: the market demand and the reliability of the machine. Based on your analysis, you assign the following probabilities and estimated returns:

• If the market demand is high and the machine is reliable, there is an 80% chance of success and an expected return of $200,000.
• If the market demand is high but the machine is unreliable, there is a 60% chance of success and an expected return of $120,000.
• If the market demand is low and the machine is reliable, there is a 50% chance of success and an expected return of $80,000.
• If the market demand is low and the machine is unreliable, there is a 30% chance of success and an expected return of $40,000.

Assuming a discount rate of 10%, should you purchase the machine?

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