The Rustic Welt Company is proposing to replace its old welt-making machinery wi

Question

The Rustic Welt Company is proposing to replace its old welt-making machinery with more modern equipment. The new equipment costs $9.9 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 $3.2. However, as the following table shows, there is some uncertainty both about future sales and about the performance of the new machinery:

   

   

Calculate the annual cost savings. Assume a discount rate of 10%. Rustic Welt does not pay taxes. (Do not round intermediate calculations. Round "PV Factor" to 4 decimal places and the final answer to 2 decimal places.)

   

Pessimistic Expected Optimistic   Sales, millions of welts 2.3        2.4     2.6       Manufacturing cost with new machinery, dollars per welt 7.9           3.2        4.9          Economic life of new machinery, years 5           8        11       

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Equivalent Annual Cost = 9.9/PVIFA(10%,8 Years) = 9.9/5.3349 = 1.86

Reduction in Manufacturing Cost = 2.4*(3.2) = 7.68

Equivalent Annual Cost Savings = -1.86+7.68 = $5.82

Answer is $5.82

Thanks.

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