Mr. Tony Stark is the CEO of a company named Stark Industries, and they are considering buying a new versus used production machine. They will sell this machine in two years (when the company's current production contract is ended). They can buy a new machine for $75,000 and will have to pay $350 per month for maintenance and repairs. The used machine costs $50,000 but its maintenance and repairs are uncertain: There is a chance of 30% it will cost $1,000 per month, and 70% it will cost $700 per month. The company believes that at the end of the two years, the salvage value (or resale value) of the new machine will be $25,000 while for the used machine it would be only $9,000.

As an alternative, Stark Industries also has the option of not buying a machine at all, and can sub-contract their works to Hammer Industries, which is known to have the needed machine already. The up-front sub-contract fee is $45,000. However, due to Hammer Industries' past record, there is a chance that they may not be able to deliver at the end of the sub-contract. Mr. Stark estimates that there is a 15% probability that Hammer Industries will not deliver; in that case, his own company has to pay a hefty penalty for not being able to fulfill the contract, with the penalty estimated at half million dollars. If Hammer Industries deliver on time, then all is good.

 

Question 

Suppose that the company is not sure about the salvage value of the used machine at the end of 2 years. Conduct a one-way analysis on the salvage value for the used machine, and compare it to the other strategies. (Note that for Questions 4, 5, and 6, you need to both draw graphs and provide the numeric details of your analysis. Also for all the three sub-questions, you will need to make assumptions on the low and high range of the corresponding parameters. You can make whatever assumptions you want, but you need to explicitly list out the range so that we can check your answers.)