Question

Bottle Limited is considering replacing its current bottling machine with a newer and more efficient one. The current machine has a book value of $25,000 and has 5 years useful life remaining. If it was sold now the firm could raise $25,000.

The price to purchase a new machine is $240,000, and shipping and installation costs would be $10,000. Estimated useful life of the new machine is 5 years, and at the end of its useful life it is estimated that it will have a salvage value of $50,000.

If installed, the new machine is expected to increase gross revenues by $65,000 per annum and annual operating costs would also decrease by $15,000 per annum.

There would be a $20,000 increase in working capital, only 20% of which is recoverable at the end of the machine’s life.

Capital Allowances is available on the straight line basis.

The company’s cost of capital is 20%

The tax rate is 40%

Required :   

(i )    What is the initial investment                                             

(ii )    What is the annual operating after tax cash flow                     

(iii )     Determine the terminal cash flow .                                  

      ( iv )    Compute the Net Present value of the investment and advise

                  the company if it should go ahead with the project.                                                                 

                                                                                                             

Answer 1