29. Decision trees (S10.3) Magna Charter is a new corporation formed by Agnes Magna to provide an executive flying service for the southeastern United States. The founder thinks there will be a ready demand from businesses that cannot justify a full-time company plane but nevertheless need one from time to time. However, the venture is not a sure thing. There is a 40% chance that demand in the first year will be low. If it is low, there is a 60% chance that it will remain low in subsequent years. On the other hand, if the initial demand is high, there is an 80% chance that it will stay high. The immediate problem is to decide what kind of plane to buy. A turboprop costs $550,000. A piston-engine plane costs only $250,000 but has less capacity. Moreover, the piston-engine plane is an old design and likely to depreciate rapidly. Ms. Magna thinks that next year secondhand piston aircraft will be available for only

$150,000.

298 Part Three Best Practices in Capital Budgeting Payoffs from the Turboprop Year 1 demand High (0.6) Low (0.4)

Year 1 payoff $150 $30 Year 2 demand High (0.8) Low (0.2) High (0.4) Low (0.6)

Year 2 payoff $960 $220 $930 $140 Payoffs from the Piston Engine Year 1 demand High (0.6) Low (0.4)

Year 1 payoff $100 $50 Year 2 demand High (0.8) Low (0.2) High (0.4) Low (0.6)

Year 2 payoff $410 $180 $220 $100

⟩ TABLE 10.5 The possible payoffs from Ms.

Magna’s flying service. (All figures are in thousands.

Probabilities are in parentheses.)