Question Details

Naughty Pine Lumber Company is evaluating a new saw with a life of two years. The saw costs $3,000, and future after-tax cash flows depend on demand for the company’s products. The tabular illustration of a probability tree of possible future cash flows associated with the new saw is as follows:

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a. What are the joint probabilities of occurrence of the various branches?

b. If the risk-free rate is 10 percent, what is (i) the net present value of each of the six complete branches, and (ii) the expected value and standard deviation of the probability distribution of possible net present values?

c. Assuming a normal distribution, what is the probability that the actual net present value will be less than zero? What is the significance of this probability?