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.
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