Question

A Machine purchased six years ago for Rs 150,000 has been depreciated to a book value of Rs 90,000. It originally has projected life of 15 years and zero salvage value. A new machine will cost Rs 350,000 and result in reduction of operating cost of Rs 40,000 in first year which will increase @8% for next eight years. The older machine could be sold for Rs 135,000. The cost of capital is 10%. The new machine will be depreciated on a straight line basis over nine year life with Rs 35,000 salvage value. The company normal tax rate is 40% whereas capital gain tax rate is 10%. Should we replace the old machine?

Answer 1

Cash flow in year 0

After tax cash inflow in sale of old machinery

= 135000 - (135000- 90000)×10%

= 130,500

Cost of new machinery = 3,50,000

Net outflow in year0 =350000-130500= 2,19,500

Cash flow in last year only

Sale of machinery = 35,000

PV = 35000/(1.1)^{9 =} 14,840

( Since written down value is equal to sale price , no tax is payable )

Yearly Cashflow

Therefore PV of yearly inflow = 2,63,423

Calculation of NPV

NPV = - 2,19,500 + 2,63,423 + 14,840

NPV = Rs 58,763

Since NPV is positive , machine should be replaced