Replacement Decision

A company is considering replacing old machine by a new one. The basic data is
in the next sheet (Problem) . Assume that depreciation for tax purpose can be
charged on straight-line basis. Any loss or profit from the sale of the asset will be
taxed at ordinary tax rate. Should the company replace old machine? Calculate
cash flows, NPV and IRR.
 Old New Incremental
Basic Data (Rs) Machine Machine cash flow
Revenue 40,000 75,000
Increase in raw material 0 12,000
Salaries 29,000 15,000
Maintenance 6,000 5,000
Defects 4,000 2,000
Before-tax savings
Tax
After-tax savings

Original life 10 5
Current life 5 5
Salvage value (end of life) 0 15,000
Current salvage value 10,000 0
Current Book value 20,000 0
Cash outlay 0 75,000
Installation cost 6,000
Marginal tax rate 35%
Required return 15%

Solution
Year 0 1 2 3 4 5
Initial outlay
Annual aftrer-tax savings
Depreciation tax shield
Total after-tax cash flow
Terminal cash flows
NCF
NPV
IRR