The Rustic Welt Company is proposing to replace its old welt-making machinery wi
ID: 2759705 • Letter: T
Question
The Rustic Welt Company is proposing to replace its old welt-making machinery with more modern equipment. The new equipment costs $9.1 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 $8.10 a welt to $4.10. However, as the following table shows, there is some uncertainty about both the future sales and the performance of the new machinery:
Conduct a sensitivity analysis of the replacement decision assuming a discount rate of 14%. Rustic does not pay taxes. Calculate the NPV. (Do not round intermediate calculations. Round your answers to the nearest whole dollar amount. Enter your answers in dollars not in millions. Negative amounts should be indicated by a minus sign.)
NPV of Replacement Decision
The Rustic Welt Company is proposing to replace its old welt-making machinery with more modern equipment. The new equipment costs $9.1 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 $8.10 a welt to $4.10. However, as the following table shows, there is some uncertainty about both the future sales and the performance of the new machinery:
Explanation / Answer
Pessimistic
Expected
Optimistic
Sales (welts) (1)
500000
600000
800000
Mfg cost per welt ($) (2)
6.1
4.1
3.1
Mfg cost per welt before new model ($) (3)
8.1
8.1
8.1
Saving due to new model (4)=(3)-(2)
2
4
5
Total saving (5)=(4)*(1)
1000000
2400000
4000000
Life (6)
10
13
16
Total saving (7)=(5)*(6)
10000000
31200000
64000000
Dis factor for life @14%
5.216
5.842
6.265
Discounted saving
52160000
182270400
400960000
In million $
52.16
182.2704
400.96
Pessimistic
Expected
Optimistic
Sales (welts) (1)
500000
600000
800000
Mfg cost per welt ($) (2)
6.1
4.1
3.1
Mfg cost per welt before new model ($) (3)
8.1
8.1
8.1
Saving due to new model (4)=(3)-(2)
2
4
5
Total saving (5)=(4)*(1)
1000000
2400000
4000000
Life (6)
10
13
16
Total saving (7)=(5)*(6)
10000000
31200000
64000000
Dis factor for life @14%
5.216
5.842
6.265
Discounted saving
52160000
182270400
400960000
In million $
52.16
182.2704
400.96
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