a.At what price for the MDX740 will the firm be indifferent between purchasing it and keeping the MX430? Assume that 44% of the price is paid on January 1, 2007 as the deposit and 56% of the price is paid on January 1, 2008.

b.At what annual cost savings will the firm be indifferent between purchasing the MX900 and keeping the MX430?

Western Wire, Inc. Western Wire, Inc. was a medium-sized cable manufacturing company located in Pueblo, Colorado, approximately 100 miles south of Denver. Founded in 1988, the company had expanded steadily and had developed solid contacts with utilities in a number of western and mid-western states. The company had several long-term contracts with firms including subsidiaries of AT&T. Western Wire's management had been particularly interested in taking advantage of the demand for soft, fully annealed copper-wire, which was increasingly used in insulated conductors in communication and power systems. The Executive Committee of the firm had been discussing the possibility of an expansion of present wire drawing facilities to meet the anticipated future demand. New equipment evaluations were in order. Roger Wilcox, the firm's controller, went to the 2006 Wire Association Convention to review the various types of machines available. He paid particular attention to manufacturers with machinery that promised high production volumes and consistent quality. After 3 days of discussions with a variety of production and industry experts, Roger called Penny Layne, a representative for a milling and machinery firm in Portland, OR. Roger asked Penny to send him some of the details on the machinery they had discussed and Penny agreed to do so. Two weeks later, Roger received the following letter: Dear Mr. Wilcox: In response to your inquiry, I am pleased to suggest three possible machines that would amply meet your needs for high quality fully annealed copper wire. Our first machine, the MX900 model, is probably the finest full-production wire-drawing machine on the market today. The wire-drawing machine and annealer are an integral unit with special electronic controls that allow the annealer to work during start-up procedures. Your production manager will well understand how this excellent machine offers lower operating costs due to less scrap and simplified operating procedures. Our second machine, the MX700, is also a very fine machine and may well meet your needs. The wire-drawing machine and annealer are an integral unit, but the annealer does not start up until operating speed is reached. This causes some scrap wire during start-up since, without the annealer operating, the first reel of out put would contain hard wire. But this may be the perfect machine for long production runs. Our third machine, the MDX740, has been an industry workhorse for many years. The wire-drawing machine and annealer are two separate units and hence a little more floor space is needed for this unit. But its proven reliability over the years offers a strong argument for you to consider this alternative. If you order one of these machines by January 1, 2007, and make the required deposit, I will personally guarantee that the machine will be set up and operating by January 1, 2008. And I will further be able to guarantee that you will receive our 2006 price less a 10 percent discount, an attractive offer indeed! The pricing is as follows: 2006 Price MX900 $3,333,334 MX700 $2,666,666 MDX740 $3,111,110 2 Less 10% discount Net full price + shipping & installing Fully installed price 333,334 $3,000,000 600,000 $3,600,000 266,666 $2,400,000 400,000 $2,800,000 311,110 $2,800,000 400,000 $3,200,000 Deposit due 1/1/2007 Balance due 1/1/2008 1,500,000 $2,100,000 1,200,000 $1,600,000 1,400,000 $1,800,000 As an item of interest, you should know that our prices have already risen by 5 percent on these machines and will rise another 8 percent on January 1. By ordering and paying your deposit prior to January 1, you in effect will be saving 23 percent compared to an order placed in 2007 when I probably will not be able to offer any discount. If you need any additional information, please do not hesitate to call me. I look forward to hearing form you in the near future. Sincerely yours, Penny Layne Sales Director After reading the letter carefully and making some notes on it, Roger sent e-mail messages to Mike Schafer, the firm's production manager, and Lew Dulfersitz, the firm's senior production accountant. He asked both men to respond to the letter from Ms. Layne and to answer some questions related to other aspects of the investment decision. Three days later, Roger received Mike's reply through the firm's internal e-mail: TO: FROM: Roger Wilcox (rwilcox@wwire.com) Mike Schafer (mschafer@wwire.com) We should seriously consider all three machines. We could buy one of these and get rid of an old MX430 that we bought two years ago from the same firm. The MX430 works fine and I'd bet we could get $800,000 if we sold it in January 2008. Pretty good since we only paid $1,200,000 for it and its book value on January 1, 2008 will be only $600,000 (we're depreciating it at $200,000 a year down to a $400,000 value). According to what I've heard there is one difference between these machines. The MX900 is so efficient that we could probably eliminate some $160,000 of inventory around here once the machine was fully operational. The other two machines need longer production runs and we would have to increase inventory, probably by about $40,000 for the MX700 and $160,000 for the MDX740. This is important, but more importantly, all three machines will save us money. So I think it would make sense to make a replacement and my personal choice would by the MX900. Two days after receiving Mike's e-mail, Roger received a reply from Lew Dulfersitz: 3 TO: Roger Wilcox (rwilcox@wwire.com) FROM: Lew Dulfersitz (ldulfersitz@wwire.com) I received Mike's e-mail and we better think twice on these new machines. By 2011, I'd bet any of these new machines would be a piece of junk. I made some phone calls and learned that these new machines are just too sophisticated for long-term use. Our MX430 will probably be worth $500,000 at the end of 2011. Do you know what my contacts estimate the new machines will be worth? About $300,000 for the almost $4,000,000 MX900, $220,000 for the MX700 and $280,000 for the MDX740. Some cash value in four years, huh? But that's the price of getting fancy equipment. And everybody knows thiseven the IRS. On our MX430, they established a $400,000 book salvage value and we cannot depreciate below this. But on the new machines, get this - the MX900 has a book salvage value at the end of four years (December 31, 2011) of only $200,000; the MX700, only $300,000; and the MDX740, only $240,000. These figures are with straight-line depreciation, which we must use for all our machines. I think we should consider my contacts' figures to be more accurate than the IRS figures, but in either case, the machines won't be worth much. And the MX900 for $3,600,000? You'll never convince me that it makes sense. I think Mike's just not thinking and I STRONGLY urge you to stay with our existing machine. Before Roger had a chance to really consider either of the positions, he got a second e-mail from Mike Schafer: TO: Roger Wilcox (rwilcox@wwire.com) FROM: Mike Schafer (mschafer@wwire.com) Hold it! Wait! What ever happened to production efficiency? Lew's response does not even touch on the rather impressive economies offered by each machine. I have done some quick figures and the MX900 will save us a bundle. Even the MX700 and MDX740, which both require a little more maintenance and have slow production capabilities, are better than the MX430. I've figured in a few probabilities and just look at the annual cash savings-operating savings mind you- which we could get with each of these machines: MX900 20% chance 60% chance 20% chance MX700 of $1,700,000 of $1,600,000 of $1,000,000 MDX740 20% of $1,000,000 50% of $860,000 30% of $700,000 25% of $1,100,000 50% of $820,000 25% of $700,000 These are savings compared to the MX430 - big savings. Even if we only got them for four years, we would be ahead with any of the machines. Don't give up the ship. After receiving the final e-mail, Roger called Lew Dulfersitz. Lew said he helped Mike estimate the annual savings, and that the figures were logical and probably correct. But, Lew insisted that the purchase of new machinery still did not make sense because it was simply too expensive. 4 That night, Roger took the responses home with him to decide whether any of the three pieces of machinery would provide a return equal to or greater than the firm's cost of capital