Q1.) Precision Engineers Ltd. Is considering a proposal to replace one of its machines. The

QUESTION

Q1.)Precision Engineers Ltd. Is considering a proposal to replace one of its machines. The following data is available regarding the same: a. The machine was purchased 4 years ago for Rs.15 lacs and has been depreciated at 25% p.a. as per the WDV method. The machine has a remaining life of 5 years, after which its salvage value is expected to be Rs.0.80 lacs. Its present salvage value is Rs.6.0 lacs. b. The new machine costs Rs.22lacs, and would be depreciated at 40% p.a. as per WDV method. Its expected life is 8 years and after 5 years it is expected to fetch Rs.6 lacs. The installation of this machine will increase the annual revenue by Rs.5 lacs, apart from decreasing the operational costs by Rs.1.10 lacs per annum. Assume no change in the depreciation rate if old machine is continued to be used. If the company uses a discounting factor of 17% p.a. for calculating the present value of future cash flow, should it go for the replacement of existing machine with the new machine? Marginal tax rate of the company is 20%. Show all your workings
Replacement of existing machine with new machine Year 0 1 2 3 4 5 6 7 8 Cash outflow -22 Total cash outflows -22 Cash inflow Revenue 5 5 5 5 5 5 5 5 Salvage value of old machine(5th year) 6 Saving in operation cost $ 1.10 $ 1.10 $ 1.10 $ 1.10 $ 1.10 $ 1.10 $ 1.10 $ 1.10 Less: Depreciation $ 8.80 $ 5.28 $ 3.17 $ 1.90 $ 1.14 $ 0.68 $ 0.41 $ 0.25 EBIT $ (2.70) $ 0.82 $ 2.93 $ 4.20 $ 10.96 $ 5.42 $ 5.69 $ 5.85 Less: Tax 20% $ 0.54 $ 0.16 $ 0.59 $ 0.84 $ 2.19 $ 1.08 $ 1.14 $ 1.17 EAT $ (2.16) $ 0.66 $ 2.35 $ 3.36 $ 8.77 $ 4.33 $ 4.55 $ 4.68 Add: Depreciation $ 8.80 $ 5.28 $ 3.17 $ 1.90 $ 1.14 $ 0.68 $ 0.41 $ 0.25 Cash inflows $ 6.64 $ 5.94 $ 5.51 $ 5.26 $ 9.91 $ 5.02 $

6 $ 4.93 Net Cash flows $ (22.00) $ 6.64 $ 5.94 $ 5.51 $ 5.26 $ 9.91 $ 5.02 $ 4.96 $ 4.93 PV Factor 17% 1 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 Present Value $ (22.00) $ 5.68 $ 4.34 $ 3.44 $ 2.81 $ 4.52 $ 1.96 $ 1.65 $ 1.40 NPV $ 3.79 Depreciation WDV 40% Year 1 2 3 4 5 6 7 8 Depreciation 8.8 5.28 3.168 1.9008 1.14048 0.684288 0.410573 0.246344 Since the present value is positive hence company should replace old machine with new machine.

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