Problem 3 There is an opportunity to acquire well-servicing equipment for $600,000. There is a 15 % probability that after acquiring the equipment we decide to NOT pursue the well-servicing business.

In this case, we could sell the equipment next year for $500,000. If we go into the well- servicing business, we anticipate annual after-tax revenues of $300,000 for 5 years, starting next year. There is a 35 % probability that we enter the business and have to overhaul and upgrade some of the equipment in 2 years. This would reduce after-tax cash flow by $200,000 in Year 2. Should we purchase the equipment? We are currently earning 20% on other investment opportunities.