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Cash Flow Estimation - Replacement

The company is considering replacing an old machine that was purchased 5 years ago for Rs 55,000 and has 5 years of remaining life left. A new high efficiency machine would cost Rs 100,000 to purchase and install, reducing operating expenses by Rs 30,000 per year, and would be depreciated over 3 years. The old machine can be sold now for Rs 35,000. The firm must determine if purchasing the new machine is worthwhile based on the initial cash outlay and incremental future cash flows over 5 years.

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Abhishek Ghosh
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36 views

Cash Flow Estimation - Replacement

The company is considering replacing an old machine that was purchased 5 years ago for Rs 55,000 and has 5 years of remaining life left. A new high efficiency machine would cost Rs 100,000 to purchase and install, reducing operating expenses by Rs 30,000 per year, and would be depreciated over 3 years. The old machine can be sold now for Rs 35,000. The firm must determine if purchasing the new machine is worthwhile based on the initial cash outlay and incremental future cash flows over 5 years.

Uploaded by

Abhishek Ghosh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Cash Flow Estimation - Replacement Analysis

A company purchased machine 5-years ago for Rs 55,000. It had an expected life of 10 years
when it was bought and its remaining depreciation is Rs 5,500 per year for each year of its
remaining life. As the older machine is robust and useful it can be sold for Rs 20,000 at the
end of its useful life.

A new alternative high efficiency machine can be purchased for Rs 100,000 to replace the old
machine. Total set up and installation costs for the machine is 20% of the price (cost) of the
machine. It has life of 5 years and it is expected that during its life it will reduce cash
operating expenses by Rs 30,000 per year, although it will not affect sales. At the end of its
useful life, the high-efficiency machine is estimated to be worthless. MACRS depreciation
will be used, and the machine will be depreciated over its 3-year class life rather than its 5-
year economic life, so the applicable deprecation rates are 33.33%, 44.45%, 14.81%, 7.41%.

The old machine can be sold today for Rs 35,000. The firm's tax rate is 35% and the
appropriate WACC is 16%.

Determine:

a. If the new machine is purchased what will be the amount of initial cash flow at Year 0?

b. What the incremental new cash flows that will occur at the end of Years 1 through 5?

c. Should the new machine be purchased?

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