Question

Curly Ramen Pte Ltd is a factory that manufactures instant noodles. The company has completed a research exercise amounting to $5,200 to improve its production process. Due to the outcome of the research, it is now considering purchasing new machines to replace its older machines. The new machines will cost $290,000 altogether, and incur an additional installation expense of $10,000. The old machines can be sold now for a proceed of $51,000, but required a disposal fee of $1,000. The table below shows the cash revenue and expenses for the existing machines:

Year	cash revenue	Cash expenses
1	300,000	200,000
2	400,000	320,000
3	500,000	440,000

The cost of capital for the company is 4%.

Required:
a. Calculate the initial investment for the proposed machines.

b. It is estimated that the new machines are expected to increase cash revenue by 35% and expenses by 10% respectively. Calculate the following:
i. Operating cash inflows for the existing machines.
ii. Operating cash inflows for the proposed new machines.
iii. Incremental cash flows for the project.

c. i. Calculate the Net Present Value for the proposed project.
ii. Should the company continue to operate the old machine or purchase the new machine? State your reason.

d. i. Explain what is sunk cost and it’s relevance to investment decisions.
ii. Identify a sunk cost from the case above.

e. If the Internal Rate of Return (IRR) for the project is 9%, should the company accept or reject the project solely based on the IRR technique? State your reason.

Answer 1

1-	Initial Investment
	cost of new machine		-290000
	Installation charges		-10000
	net sale proceeds from old machibe		50000
a-	net initial investment		-250000
b-
2-	operating cash inflow from existing machine
	Year	1	2	3
	revenue	300000	400000	500000
	expenses	200000	320000	440000
	operating cash flow	100000	80000	60000
	operating cash inflow from newmachine
	Year	1	2	3
	revenue = previous*(1+groowth rate) growth rate = 35%	405000	540000	675000
	expenses = previous*(1+groowth rate) growth rate = 10%	220000	352000	484000
	operating cash flow	185000	188000	191000
	Incremental cash flow = operating net cash flow from new machine-operating cash flow from old machine	85000	108000	131000
	Year	0	1	2	3
	incremental cash flow	-250000	85000	108000	131000
	present value of incremental cash flow = incremental cash flow/(1+r)^n r =4%	-250000	81730.77	99852.07101	116458.52
c	NPV = sum of present value of cash flow at 4%	48041.36322
	Yes company should purchase the equipement as NPV is positive
d	Sunk cost is called the historical cost or cost which has incurred in past and this sunk cost is not taken into consideration for capital budgeting decisions
	From the above case example of sunk cost is research expenses of 5200
	Yes company should purchase the equipement as NPV is positive
e	Yes as IRR is 9% which is more than the required rate of return of 4% so it should be considered for implementation