NPV Analysis Under Risk. The Connors Company is considering a $60,000 investment in a machine that will reduce operating costs. The following estimates regarding cash savings, along with their probabilities of occurrence, have been made:
Annual Cash Savings Useful Life
Event Probability Event Probability
$20,000 0.30 9 years 0.40
$14,000 0.30 8 years 0.40
$12,000 0.40 6 years 0.20
(a) Compute the expected annual cash savings and useful life. Determine whether the machine should be purchased, using the NPV method
(b) The company wishes to see whether the machine would be a good investment if each of its most pessimistic estimates, but not both at the same time, came true. Determine whether the investment would be desirable if: (1) the useful life is the expected value computed in part (a), and annual cash flows are only $12,000; (2) the annual cash flows are equal to the expected value computed in part (a) and the useful life is only 6 years.