Question

The management of a company is considering replacing a number of old looms in the mill’s weave room. The looms to be replaced are two 220-cm President looms, sixteen 135-cm President looms, and twenty-two 185-cm Draper X-P2 looms. The company may either replace the old looms with new ones of the same kind or buy 21 new shutterless Pignone looms. The first alternative requires the purchase of 40 new President and Draper looms and the scrapping of the old looms. The second alternative involves scrapping the 40 old looms, relocating 12 Picanol looms, and constructing a concrete floor, plus purchasing the 21 Pignone looms and various related equipment. Following are the revenue and expense predictions:

Description	Alternative 1	Alternative 2
Machinery/related equipment	$2,150,000	$900,000
Annual revenues due to the new looms	$2,000,000	$1,500,000
Annual labour cost	$250,000	$300,000
Annual O&M cost	$1,000,000	$700,000
CCA Rate	30%	30%
Project life	8 years	8 years
Salvage value	$100,000	$40,000

The corporate executives feel that various investment opportunities available for the mill will guarantee a rate of return on investment of at least (MARR) 10%. The mill’s marginal tax rate is 40%. Due to uncertainty, the following variabilities in estimates should be considered: revenues ± 30%, labour cost ± 40%, and annual O&M cost ± 20%. Assume that each of these variables can independently deviate from its base value.
a] Assuming that uncertain variables change once at a time, use NPW to conduct sensitivity analysis. Ideally, you should plot the relationship between percentage change in a variable and NPW.
b] Now consider that each variable can take only three possible outcome within the range of possible outcome: lowest value, base value, and highest value. Each outcome can happen with a probability: 0.15, 0.7, and 0.15, respectively. Considering the distributions of the three uncertain variables, predict the probability distribution of NPW for each alternative. Each NPW will have 27 possible outcome (3x3x3) and you are required to do that for each alternative.
c] If Alternative 1 is chosen over Alternative 2, what is the probability that this decision is correct?
Hints:
-do not forget to calculate income taxes and disposal tax effects
-You can you spreadsheet applications if you communicate your solution in a way which enables the teaching assistant to independently replicate your final answer. You can show sample calculations as a way to communicate with the teaching assistant.
-Please assume that the given MARR is market interest rate and all dollars are current.

Note: If not mentioned, [1] the half-year rule applies and [2] all rates are annual.

(could i get an example calculations and explanations as to why things are like that?)

Answer 1