Because the economy suffered a significant decline just a year prior, there was uncertainty about the economy in general, and, very much affected by the economy, the demand for shipping and containers. Market analysts predicted that 2010 provide certain information about the likelihood of recovery. At this point, in 2009, the likelihood of 2010 being a good year is estimated at 40% and the likelihood of 2010 being a bad year is estimated at 60%. If 2010 is a good year, the likelihood of subsequent 2011 and on being good years (recovery) is 80%, and the likelihood of these subsequent years being bad years (recession) is 20%. If 2010 is a bad year, the likelihood of subsequent 2011 and on being good years (recovery) is 20%, and the likelihood of these subsequent years being bad years (recession) is 80%. In 2011, the situation will get resolved, and everyone will know whether subsequent years are good or bad with certainty.
Since he has not dealt with uncertainty regarding the future state of the economy before, Mr. Johnson is bewildered and asks your help in determining the course of action regarding this opportunity. In particular, should the firm buy the equipment in 2009, 2010, or not buy at all? Mr. Johnson has estimated that the WACC for the company in certain times has been 10%. Assume that the project has no tax implications, i.e. the tax rate of 0%. Also assume that the firm can shut down the project any time at no cost.