Unmondo SpA is proposing to replace its old DVD stamping machinery with more modern equipment geared towards the blu-ray technology. The new machinery costs €9 million (the existing machinery has no value). The attraction of the blu-ray stamper is that it is expected to cut manufacturing costs from their current level of €8 per DVD to €4 per blu-ray disc. However, as the following table shows, there is some uncertainty about future sales and the performance of the blu-ray technology.

(a) Carry out a sensitivity analysis of the replacement decision, assuming a discount rate of 12 per cent. Unmondo does not pay taxes.

(b) Unmondo SpA could commission engineering tests to determine the actual improvement in manufacturing costs generated by the proposed new blu-ray disc stamper. The study would cost €450,000. Would you advise Unmondo to go ahead with the study?

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Sales, millions of units Manufacturing cost, /unit Life of new machine Pessimistic 0.4 6 7 years Expected 0.5 4 10 years Optimistic 0.6 3 13 years