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 net initial cash outlay

b) Determine the net annual cash flows

c) Determine the net terminal cash flows

d) Determine the net present value for the new machine

e) What is the replacement decision for the company?

Answer 1

Hi,

I have solved this question by considering a capital gain tax on the sale of the old new machine after calculating the book value of the Old Machine. Net Working Capital already included in the initial outlay and recovered working capital shown in terminal cash flow. Depreciation first reduced while calculating the present value from profit, to take tax benefit, and then add to cash flow. As depreciation do not affect the cash position of an entity.

Any doubts are welcome