Question

Zankel Incorp is considering replacing its old machine with a new machine. The cost of a new machine is RM 300,000 with a useful life of 4 years. The machine has an estimated salvage value of RM 45,000. The cost of installing this new machine will be RM 20,000. In the initial period, RM 125,000 in net working capital is required and to be recovered at the ending life of the machine. The company was using the present machine for 4 years and it has a remaining useful life of 2 years. The machine was bought at RM 200,000 and has a salvage value of RM 20,000. Currently, the machine can be sold at RM 90,000 and normally the company adopts straight- line method as a depreciation strategy. The new machine is expected to result in changes as follows:

• Increase in annual sales by RM 80,000.

• Reduction in annual defect cost by RM 6,000.

• Increase in annual operating cost by RM20,000

If corporate tax is 30%, the capital gain tax rate is 15%, and the required rate of return is 10%, determine:

a) Determine the cost of asset for the new machine

b) Determine the annual depreciation for the new machine

c) Determine the annual depreciation for the present machine

d) Determine the book value for the present machine at year 2

e) Determine the tax liability for the present machine

f) Determine the net initial cash outlay

g) Determine the net annual cash flows

h) Determine the net terminal cash flows

I) Determine the net present value for the new machine

j) What is the replacement decision for the company

Answer 1

a)

cost of new machine = 300,000 + 20,000 = $320,000

b)

given straightline depreciation

depreciation = (cost - salvage) / useful,ife

= (320,000 - 45000) / 4

= $68,750

c)

present machine cost = 200,000

useful life = (4+2) = 6 years

salvage value = 20,000

Depreciation = (200,000 - 20,000) / 6

= $30,000

d)

book value at year 2:

depreciation for 2 years = 2*30,000 = 60,000

book value = 200,000 - 60,000 = $140,000

e)

tax liability:

present book value(at year 4):

Depreciation for 4 years = 4*30,000 = 120,000

book value = 200,000 - 120,000 = 80,000

sale value = 90,000

capital gains = 90,000 - 80,000 = 10,000

capital gain tax rate = 15%

tax liability = 10,000*15% = $1500

f)

net initial outlay = cost of new machine + initial net working capital - after tax sale value

= 320,000 + 125000 - (90000 - 1500)

= $356,500

first lets answer 'h' part and then remaining all together:

h)

terminal cash flow = salvage value of new machine + recovery of working capital

= 45000 + 125000

= $170,000

answer for g and i:

j)

since NPV is negative it is recommended not to replace the machine.