Whity Berhad bought a used printing machine 5 years ago hoping it would serve its printing
needs for 10 years. Although the machine had performed as expected for the last five years,
newer and more highly automated colour printers have now become available. The existing
machine has a book value of RM100,000 and is being depreciated at RM20,000 a year toward a
zero-salvage value in 5 years. However, today the machine can be sold for only RM50,000.
The appeal of the new machine is that it is completely automated (requires two fewer
employees whose combined salaries and fringe benefits total RM110,000 per year) and also
does color printing. The ability to sell color ads is expected to increase the paper ads revenues
from RM150,000 per year to RM200,000. However, the added color printing feature comes at
the cost of higher maintenance and ink cost of RM100,000 compared to only RM80,000 for the
older machine. The new machine being considered costs RM300,000 to purchase, plus an
additional RM10,000 in shipping and installation costs. Last year, the company also spent
RM3,000 to send staff for training on the new machine. The new machine will be depreciated
using straight line method. The expected disposal value of the new machine is RM100,000 in 5
years.
Whity Berhad faces a 24% marginal tax rate. The beta factor of this new investment is 2.0. The
company has a target capital structure of 50% equity and 50% debt. The cost of debt after-tax is
10%. The risk-free rate is 4% and market risk is 8%.
Required:
a) Would you argue for the cost of shipping and installation, and training to be included in
the calculation of initial cash outflow? Justify your answer. (3 marks)
b) What is the cost of equity for the new project? (3 marks)
c) Calculate the initial cash outflow associated with replacing the older printing machine
with the new machine. (4
marks)
d) Calculate the net present value if the company decided to buy the new printing machine.
(8
marks)
e) Should the company proceed with buying the new machine? (2 marks)
(Total: 20 Marks)
Answer:
Cost of equity
= 4% +(8%-4%)2 = 12%
WACC = 0.5(10%) + 0.5(12%) = 11%
Terminal Value of old
asset
CF
Book value 100000
Disposal value 50000 50000
Loss on
disposal -50000
(+) tax savings
(24%) 12000
Terminal Value of old
asset 62000
Initial outlay of new
asset
Asset cost 300000
(+) Installation and shipping cost 10000
Total Cost 310000
(+) NOWC 0
(-) Terminal value of old
asset 62000
Initial outlay of new
asset 248000
Depreciation Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr10
Old 2000
Asset 20000 0 20000 20000 20000
6200
New Asset 62000 0 62000 62000 62000
4200
42000 0 42000 42000 42000
Discounted Cash Inflow
Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Total
Increase sales 50000 50000 50000 50000 50000
(+) Decrease in labour 110000 110000 110000 110000 110000
(-) Increase maintenance 20000 20000 20000 20000 20000
(-) Depreciation 42000 42000 42000 42000 42000
Net Profit Before Tax 98000 98000 98000 98000 98000
(-)Tax Payable (24%) 23520 23520 23520 23520 23520
74480 74480 74480 74480 74480
(+) Depreciation 42000 42000 42000 42000 42000
116480 116480 116480 116480 116480
PVIF (11%) 0.9009 0.8116 0.7312 0.6587 0.5935
104936. 94535.1 85170.1 76725.3 69130.8 430498.
8 7 8 8 8 4
Terminal value of new asset
CI
31000
Total Cost 0
21000
(-)Acc. Depreciation 0
10000
Book Value 0
10000
Disposal Value 0 100000
Gain on disposal value 0 0
(+) NOWC 0
100000
PVIF (11%,5) 0.5935
59350
NPV = Discounted cash inflow + terminal value (new asset) - Initial outlay new asset
430498.4+ 59350 -
248000
= 241848.4
