Question

Delafono is evaluating the option of replacing an old pasta-making machine that is expected not to...

Delafono is evaluating the option of replacing an old pasta-making machine that is expected

not to last more than two years. During that time, the machine is expected to generate a cash

inflow of 20,000 per year. It could be replaced by a new machine at a cost of 150,000. The

new machine is more efficient than the current one, and as a result, it is expected to generate

a net cash flow of 75,000 per year for three years. The management of Delafono is

wondering whether to replace the old machine now or wait another year. Delafono’s cost of

capital is 10 per cent.

Required:

4.1. Assume that the current resale value of the old machine is zero and that the new

machine will also have a zero resale value in the future. What is the annual equivalent

cash flow of using the new machine?

4.2. What should the management of Delafono do? Explain

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Homework Answers

Answer #1

4.1)Statement showing annual equivalent cost of using new machine

Particulars 0 1 2 3
Cost of new machine -150000
Revenue from new machine 75000 75000 75000
Revenue foregone of old machine -20000 -20000
Cash flow -150000 55000 55000 75000
PVIF @10% 1 0.9091 0.8264 0.7513
Present value -150000 50000 45454.55 56348.61 1803.16
PVIFA(10%, 3 years) 2.49
EUAC( 1803.156/2.4869) 725.06

4.2) The management of Delafono should replace the old machine with new one since it will result in positive cash flow

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