Question

Q. 1: Two years ago, a company purchased a machine. Currently, the machine can be sold for Rs. 2500 having a book value of Rs. 2100. The remaining life of the machine is 6 years and is depreciated using a straight-line depreciation method. Therefore, it records Rs. 350 per year as an annual depreciation expense. The company may sell the machine for Rs. 500 after it completes its useful life if it is not replaced with a new one which is technologically more advanced. A representative of high-tech manufacturing machines approaches the company and offers to replace its old machine with a new one for Rs. 8000. This new machine would be having Rs. 800 as an estimated scrap value at the end of its expected useful life of 6 years. The applicable depreciation rates according to 5-years MACRS class life are 20 percent, 32 percent, 19 percent, 12 percent, 11 percent and 6 percent, respectively. This new machine would help the company increase its revenues by 1000 annually and decrees its operating expenses by 1500 annually. However, the company would be needed to increase its inventories by Rs. 2000 as well as the accounts payables by Rs. 500. The composite WACC and marginal tax rate of the company are 11 percent and 40 percent, respectively. Being the financial consultant hired by the company, you are required to calculate net present value (NPV) and internal rate of return (IRR) and suggest whether the company should replace its old machine or not?

Answer 1