Question

Capital Budgeting H & M Investment Ltd currently uses an injection molding machine that was purchased two years ago .This machine is being depreciated on a straight line basis towards a $600 000 salvage value , and it has six years of remainig life .Its current book value is $2600 000 and it can be sold at $2760 000 at this point time .The company is offered a replacement machine ,which has a cost of $8000 000, an estimated useful life of fiveyears .It is estimated that its salvage value at the end of five years will be $800 000 but will be sold for $735 000. The machine will also require $87 000 for it to be installed .In addition ,the replacement machine would permit an output expansion , so that sales would rise by $1 150 000 per annum. The new machine is greater in efficiency such that operating expenses would decline by $950 000 per annum .In addition the machine would require that inventories be increased by $2 200 000 and accounts payable would also increase by $590 000 .The company effective tax rate is 30% and its cost of capital is 15% per year. Assume that deprecition tax allowable. Determine initial investment, After tax relevant cash flow and Terminal cashflows Advise the company on whether to invest in the new asset or not, using the following 1. Net present value approach 2. Profitability index approach 3. Internal rate of return 4. Modifying internal rate of return 5. Payback period if the company requires one and half years.

Answer 1

Based on the given data, pls find below workings for cash flows, NPV, IRR, MIRR, PI and Payback Period:

Assumption : It is assumed that the working capital invesment is recovered back at Terminal Year;

Initial Cash Flow = Net amount of outflow $ 6985000

Terminal Cash Flow = Net amount of inflow of $ 2364500;

While the project is with positive NPV and IRR % higher than that of the discounting factor, since the Payback is higher than the life of the project, this is not recommeded (as the company requires payback of less than one and hlaf years)