Problem:
The Rustic Welt Company is proposing to replace its old welt-making machinery with more modern equipment. The new equipment cost $9 million (the existing equipment has zero salvage value). The attraction of the new machinery is that it is expected to cut manufacturing costs from their current level of $8 a welt to $4. However, as the following table shows, there is some uncertainty both about future sales and about the performance of the new machinery:
|
|
Pessimistic
|
Expected
|
Optimistic
|
|
Sales, millions of welts
|
.4
|
.5
|
.7
|
|
Manufacturing cost of the new machinery, $ per welt
|
6
|
4
|
3
|
|
Economic life of new machinery, years
|
7
|
10
|
13
|
Conduct a sensitivity analysis of the replacement decision, assuming a discount rate of 12%. Rustic Welt does not pay taxes.