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problem 1: Baobab rolling mills owns a lathe machine that was purchased 10 years ago at sh. 75 million. The machine had an expected life of 15 years at the time it was purchased, and management estimated and still believes that the salvage value will be 0 at the end of its 15 years life. The machine is being depreciated at on a straight line basis, thus opts annual depreciation charge is sh. 5 million, and its current book value is sh.25 million. The R&D manager reports that a new special purpose machine can be purchased for sh. 120 million(comprising freight and installation of sh. 10 million and 30 million correspondingly) which, over it 5 year life will reduce labor and raw materials usage enough to cut operating costs from sh. 70 million to sh. 40 million. It is estimated that the new machine can be sold for sh. 20 million at the end of its life. The old machine actual present market value is sh. 10 million that is below its sh. 25 million book value. If the new machine were acquired, the old lathe would be sold to the other company. Networking capital requirements will rise by sh. 10 million at the time of replacement. The company is in 40% tax bracket and the cost of capital is 12%. The company will maintain the straight basis of depreciating similar machines. Find out the following:

A) Net cash flows at the time of replacement?

B) Incremental cash flows over the life of new lathe?

C) Net terminal cash flows at the end of new machines life?

D) Payback period for the replacement decision?

E) Net current value of the new lathe?

F) The replacement decision internal rate of return?

G) Should the decision to substitute be undertaken?

Corporate Finance, Finance

  • Category:- Corporate Finance
  • Reference No.:- M91092

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