MGT-401

Financial Managenment

QUIZ# 3

Service factory is planning to install new machine in leather department which will cost Rs 150,000 with
an installment cost of Rs 10,000. New machine will be depreciat using a 3-year MACRS recovery period
with 4 year useful life. An old plant is in use and was installed 1 year ago cost Rs 50,000. The machine is
being depreciated under MACRS using a 5-year recovery period; it has 4 years of usable life remaining. If
we sold old machine today it will sell at Rs 30,000. Also If new machine is acquired, working capital will
expected to increase by 30,000Rs. Following are revenues and expenses (excl. depreciation ) for each
machine for next 4 years.

Year Old machine Old machine New machine Old machine

(Revenue) Expenses (excl. (Revenue) Expenses (excl.
depr.) depr.)
1 50,000 25,000 110,000 30,000
2 50,000 25,000 100,000 30,000
3 50,000 25,000 120,000 30,000
4 50,000 25,000 120,000 30,000
At the end of 4 years, the market value of the old machine will be Rs 30,000, but the new machine could
be sold to net Rs 50,000 before taxes. Both ordinary corporate income and capital gains are subject to a
40% tax.

1. Determine the initial investment associated with the proposed replacement decision.
2. Calculate the incremental operating cash inflows for years 1 to 4 associated with the proposed
replacement.
3. Calculate the terminal cash flow associated with the proposed replacement decision.
4. Draw relevant cashflows on a time line for both machines.