A manufacturing is going to replace an existing machine by an automatic high tech machine. The existing machine purchased two years ago having a useful life three years for Rs.260,000. The estimated…

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a. Net Cash Outlay

The net cash outlay is the total initial investment required to replace the existing machine with the new automatic high-tech machine. It includes:

1. Cost of new machine: Rs. 300,000
2. Installation and erection cost: Rs. 20,000
3. Additional working capital required: Rs. 20,000
4. Market value of existing machine (salvage value): Rs. 150,000 (this reduces the net outlay)

Calculation: $$\text{Net Cash Outlay}=(\text{Cost of new machine}+\text{Installation cost}+\text{Working capital})-\text{Market value of existing machine}$$ $$=(300,000+20,000+20,000)-150,000$$ $$=340,000-150,000=\boxed{190,000}$$

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b. Differential Annual Cash Flow After Tax (CFAT)

The differential annual cash flow after tax includes:

1. Annual operating savings: Rs. 80,000
2. Tax savings from depreciation (since depreciation reduces taxable income)

Step 1: Calculate Depreciation for the New Machine

The new machine has a 3-year life and salvage value of Rs. 20,000. Using the fixed instalment method (straight-line depreciation): $$\text{Annual Depreciation}=\frac{\text{Cost}-\text{Salvage Value}}{\text{Useful Life}}$$ $$=\frac{300,000+20,000-20,000}{3}=\frac{300,000}{3}=\boxed{100,000\text{ per year}}$$

Step 2: Calculate Tax Savings from Depreciation

Tax rate = 25% $$\text{Tax Savings}=\text{Annual Depreciation}\times \text{Tax Rate}$$ $$=100,000\times 0.25=\boxed{25,000\text{ per year}}$$

Step 3: Calculate Differential CFAT

The differential CFAT is the operating savings + tax savings from depreciation: $$\text{Differential CFAT}=\text{Annual Operating Savings}+\text{Tax Savings}$$ $$=80,000+25,000=\boxed{105,000\text{ per year (Years 1, 2, and 3)}}$$

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c. Final Year CFAT

In the final year (Year 3), the salvage value of the new machine (Rs. 20,000) is recovered, and the working capital (Rs. 20,000) is released. Additionally, the tax savings from depreciation still apply.

Step 1: Salvage Value Recovery

The salvage value (Rs. 20,000) is received at the end of Year 3. Since the book value of the machine at the end of Year 3 is Rs. 20,000 (salvage value), no gain or loss is recorded. Thus, no tax impact arises from salvage value recovery.

Step 2: Working Capital Release

The additional working capital (Rs. 20,000) is released at the end of Year 3, which is a cash inflow and is not taxable.

Step 3: Final Year CFAT Calculation

The final year CFAT includes:

1. Annual operating savings: Rs. 80,000
2. Tax savings from depreciation: Rs. 25,000
3. Salvage value recovery: Rs. 20,000 (no tax impact)
4. Working capital release: Rs. 20,000

$$\text{Final Year CFAT}=80,000+25,000+20,000+20,000=\boxed{145,000}$$

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d. Should the Existing Machine Be Replaced? (NPV & IRR Analysis)

We will evaluate the Net Present Value (NPV) and Internal Rate of Return (IRR) to determine whether the replacement is financially viable.

Step 1: Cash Flow Projections

Step 2: Calculate NPV (Discount Rate = 10%)

The NPV formula is: $$NPV=\sum \frac{C{F}_t}{(1+r{)}^t}-\text{Initial Investment}$$ where:

• $C{F}_t$ = Cash flow at time $t$
• $r$ = Discount rate (10% or 0.10)
• $t$ = Time period

Calculations:

1. Year 0: $-190,000$
2. Year 1: $\frac{105,000}{(1.10{)}^1}=95,454.55$
3. Year 2: $\frac{105,000}{(1.10{)}^2}=86,776.86$
4. Year 3: $\frac{145,000}{(1.10{)}^3}=109,659.26$

$$NPV=-190,000+95,454.55+86,776.86+109,659.26=\boxed{101,890.67}$$

Since NPV > 0, the project is acceptable.

Step 3: Calculate IRR

The IRR is the discount rate that makes NPV = 0. We solve: $$-190,000+\frac{105,000}{(1+IRR{)}^1}+\frac{105,000}{(1+IRR{)}^2}+\frac{145,000}{(1+IRR{)}^3}=0$$

Using trial and error or financial calculator:

The IRR ≈ 28% (exact calculation may require interpolation).

Step 4: Decision Rule

Conclusion: Since both NPV > 0 and IRR > Cost of Capital (10%), the existing machine should be replaced by the automatic high-tech machine.

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Final Answer Summary