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Problem 3. (6 points) An investor has paid $1,000,000 for a machine that is estimated to have a 70% probability of successfully producing 5,000
Problem 3. (6 points) An investor has paid $1,000,000 for a machine that is estimated to have a 70% probability of successfully producing 5,000 product units per year for each of the next three years when the machine is estimated to be obsolete with a zero salvage value. The product price is the unknown to be calculated, so it is estimated to be SX per unit in year 1 escalated dollars and to increase 10% in year two and 6% in year three. Total operating costs are estimated to be $8,000 in year one escalated dollars and to increase 15% in year two and 8% in year three. The annual inflation rate is estimated to be 7%. What must be the year one, two, and three escalated dollar product selling price if the investor is to receive a 12% annually compounded constant dollar expected DCFROR on invested dollars? Consider zero cash flow to be realized 30% of the time the project fails. This assumes that the equipment dismantlement costs will offset any salvage value benefits.
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