Question

3. CK Company uses the machine for cleaning the furniture. The current machine has purchased since the three years ago. The initial cost is $300,000. The machine has the useful life 5 years since the date of purchases. The residual value is $50,000. The Current machine can generate the cash revenue per year is $100,000 and cash operating costs is $60,000 per year. If the company continues to keep or use the current machine, it will have the repairing expense $20,000 at the end of year 4. (remaining useful life of old machine useful life of new machine) At the end of year 3 of using the old machine, the company decides to purchase the new machine. The new machine's initial cost is $400,000. The new machine required the Working Capital equals to $10,000. It will generate the cash revenue per year is $200,000 and cash operating costs is $100,000 per year. The new machine's residual value is $40,000. The new machine's useful life is 6 years. The company uses the straight line method in calculation of depreciation. If the new machine is purchased, the current (old) machine can be sold at $160,000. Tax Rate is 30%. Cost of Capital is 10%. At the end of useful life of new machine, the recovery WC is 80% of initial WC required. Required: 1.Calculate NPV to decide whether the company purchases the new machine and sold the old machine or not 2.Calculate NPV to decide whether the company purchases the new machine and keep the old machine as a reserve machine or not

Answer 1

ANS : For calculating the NPV we need to prepare the cash flow so as to get the details of the cash flow of the machine 1 and machine 2 and after the same we will be able to calculate the present value of the machine which will help us in getting the NPV of the machine under different condition

Present value will be calculated by

Present Value= Net cash flow of the year /(1+rate of interest) ^year

NPV of Machine 1 for the life of 6 years = - $136571.02 ( See cash Cash Flow 1 chart)

NPV of machine one if its sold after 3 year= $ 51915.85 (See cash Flow 2 chart)

NPV of machine 2 = $ 939.79 (See cash Flow 3 chart)

Ans 1) Yes, the company should purchase the new machine and sell the old machine as it is having a positive NPV of $51915.85 + $ 939.79= $ 52,855.64 is the return on both the machines.

Ans 2 ) No , as even after keeping the first machine as reserve the NPV will be negative for the first machine to retain further i.e

-136571.02+939.79= $ 135631023

Ans 3) No , as the NPV will be negative for the first machine to retain further i.e

-136571.02+939.79= $ 135631023

1)Cash Flow and NPV of Machine -1 for 5 years of life

INTEREST RATE 10% CASH FLOW MACHINE 1 YEAR O MACHINE 1 COST$ 3,00,000.00 RESIDUAL VALUE $ 50,000.00 REVENUE $ 1,00,000.00 $ 1,00,000.00 $ 1,00,000.00 $1,00,000.00 $ 1,00,000.00 OPERATING COST $ 60,000.00 $ 60,000.00 $ 60,000.00 $ 60,000.00 $ 60,000.00 REPAIRING EXPENSES $ 20,000.00 DEPRICIATION $ 60,000.00 $ 60,000.00 $ 60,000.00 $ 60,000.00 $ 60,000.00 GROSS CASH FLOW $-3,00,000.00 $ -20,000.00 $ -20,000.00 $ -20,000.00 $ - 40,000.00 $ 30,000.00 $ 9,000.00 ADD DEPRICIATION $ 60,000.00 $ 60,000.00 $ 60,000.00 $ 60,000.00 $ 60,000.00 NET CASH FLOW $-3,00,000.00 $ 40,000.00 $ 40,000.00 $ 40,000.00 $ 20,000.00 $ 81,000.00 PRESENT VALUE $-3,00,000.00 $ 36,363.64 $ 33,057.85 $ 30,052.59 $ 13,660.27 $ 50,294.63 $-1,36,571.02 NPV TAX

Cash flow and NPV 2(If the machine is sold in the year 3)

CASH FLOW MACHINE 1 YEAR MACHINE 1 COST$ 3,00,000.00 RESIDUAL VALUE $1,60,000.00 REVENUE $1,00,000.00 $ 1,00,000.00 $1,00,000.00 OPERATING COST $ 60,000.00 $ 60,000.00 $ 60,000.00 REPAIRING EXPENSES DEPRICIATION $ 60,000.00 $ 60,000.00 $ 60,000.00 GROSS CASH FLOW $-3,00,000.00 $ -20,000.00 $ 1,40,000.00 $1,40,000.00 TAX ADD DEPRICIATION $ 60,000.00 $ 60,000.00 $ 60,000.00 NET CASH FLOW $-3,00,000.00 $ 40,000.00 $ 2,00,000.00 $2,00,000.00 PRESENT VALUE $-3,00,000.00 $ 36,363.64 $ 1,65,289.26 $1,50,262.96 $ 51,915.85 NPV

3) Cash flow and NPV of Machine 3 for 6 years

INTEREST RATE 10% CASH FLOW MACHINE 2 YEAR MACHINE COST $ 4,00,000.00 WORKING CAPITA $ - 10,000.00 8000 REVENUE $ 2,00,000.00 $ 2,00,000.00 $ 2,00,000.00 $ 2,00,000.00 $ 2,00,000.00 $ 2,00,000.00 OPERATING COST $ 1,00,000.00 $ 1,00,000.00 $1,00,000.00 $1,00,000.00 $ 1,00,000.00 $ 1,00,000.00 RESIDUAL VALUE 40000 DEPRICIATION $ 66,666.67 $ 66,666.67 $ 66,666.67 $ 66,666.67 $ 66,666.67$ 66,666.67 GROSS CASH FLOV $ -4,10,000.00 $ 33,333.33 $ 33,333.33 $ 33,333.33 $ 33,333.33 $ 33,333.33 $ 81,333.33 $ 10,000.00 $ 10,000.00 $ 10,000.00 $ 10,000.00 $ 10,000.00 $ 24,400.00 ADD DEPRICIATION $ 66,666.67 $ 66,666.67$ 66,666.67$ 66,666.67$ 66,666.67 $ 66,666.67 $ -4,10,000.00 $ 90,000.00 $ 90,000.00 $ 90,000.00 $ 90,000.00 $ 90,000.00 $ 1,23,600.00 PRESENT VALUE $ -4,10,000.00 $ 81,818.18 $ 74,380.17 $ 67,618.33 $ 61,471.21 $ 55,882.92 $ 69,768.98 $ TAX 939.79 NPV