a company wants to replace a three year old machine with a new one costing $ 1 million. Marketing study was done last year costing $ 100 000. The new machine costs $ 200 000 to install and will last for 5 years. It is expected sales will increase from the current level of $ 7 million by 10% for the first year and only the increased sales will increase by 10% for each of the next four years. Initial stages of project inventory will increas by $100 000, accounts receivable by $ 40 000 and creditors by $20 000. Working capital will not change again during the project. Storing space which is currently being let our for $50 000 per year will now be utilised for the increased inventory. The old machine was originally purchased for $ 1.2 million 3 years ago and can be sold today for $ 200 000. If not sold it can last for another 5 years. Variable costs are 30% of sales and fixed costs amount to $ 100 000 for the new machine have to be incurred. The estimated market value of the machine in 5 years is R 50 000. Both machines qualify for a 5 straight line depreciation, tax rate 30% and cost of capital 12%. Use NPV and IRR to determine whether old machine must be replaced or not

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New Machine
R'000
Installed cost of proposed machine:
Cost of New Machine R 1 000
Installation Cost R 200
Total Cost of Machine R 1200

- After cost sales of present machine
Market Value of machine R 200
Book Value = (120000/5) x 3 R720
Loss / Gain R520
Tax Savings @ 0.3 R165
Total sales cost of present machine R365

+ Change in Networking Capital

CA: Inventory + AR: 100+ 40 R140
CL: Creditors + Inventor: 50 + 20 R 70
Total Change in NWC R70



Year 1 Year 2 Year 3 Year 4 Year 5
Revenue R7 700 000 R7 770 000 R7 777 000 R7 777 700 R7 777 770
Expenses
VC R2 310 000 R2 331 000 R2 333 100 R2 333 310 R2 333 331
FC R100 000 R100 000 R100 000 R100 000 R100 000
Forgone Rental cost R50 000 R50 000 R50 000 R50 000 R50 000
Total Expenses R(2 460 000) R(2 481 000) R(2 483 100) R(2 483 310) R(2 483 331)
Operating Profit R5 240 000 R5 289 000 R5 293 900 R5 294 390 R5 294 439
Depreciation R(240 000) R(240 000) R(240 000) R(240 000) R(240 000)
EBIT R5 000 000 R5 049 000 R5 053 900 R5 054 390 R5 054 439
Interest @ 12% R(600 000) R(605 880) R(606 468) R(606 527) R(606 533)
EBT R4 400 000 R4 443 120 R4 447 432 R4 447 863 R4 447 906
Tax @ 0.3 R(1 320 000) R(1 332 936) R(1 334 230) R(1 334 359) R(1 334 372)
Net Income R3 080 000 R3 110 184 R3 113 202 R3 113 504 R3 113 534
Add Depcreciation R240 000 R240 000 R240 000 R240 000 R240 000
Cash flow R3 320 000 R3 350 184 R3 353 202 R3 353 504 R3 353 534



Terminal Growth Rate: Market Value: R50 000
Tax @ 0.3 : (R15 000)
+∆ NWC: 70000
105 000


NPV R 90 912.38