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SBM Printing Ltd is considering the replacement of one of its existing printing machines
SBM Printing Ltd is considering the replacement of one of its existing printing machines. The new machine costs $120,000 and if purchased, will bring about an increase in contribution of $35,000 each year for a period of 3 years. As it is fully automated, it will also reduce salary expenses by $20,000 each year. The depreciation per year is $40,000. At the end of the 3-year period, the new machine will be fully depreciated and will be scrapped for $8,000. The existing machine was purchased 3 years ago at a cost of $90,000. Currently, it has been fully depreciated and can be sold for $5,000. Assume tax rate is 20% and the cost of capital is 10% p.a. It is a policy of the company to accept projects with a minimum NPV of $5,000 and a maximum payback period of 3 years Calculate the initial investment resulting from the replacement of the existing machine a)
b) Advise SBM Printing Ltd if it should replace its old machine using (INPV (1) Payback Initial investment = b) Operating cashflow: Yr 1-3 (1) NPV (11) Payback
Expert Solution
| Net present value = Present value of cash inflow- Initial cash outflow | ||||||||||||||||||||||||||||||||
| Calculation of Initial cash outflow | ||||||||||||||||||||||||||||||||
| Particular | Amount | |||||||||||||||||||||||||||||||
| Purchase of new machine | $1,20,000.00 | |||||||||||||||||||||||||||||||
| Less: Cash received from scrap | $5,000.00 | |||||||||||||||||||||||||||||||
| Add: Tax (5000-0)*20% | $1,000.00 | |||||||||||||||||||||||||||||||
| Total Initial cash outflow | $1,16,000.00 | |||||||||||||||||||||||||||||||
| Calculation of present value of cash inflow | ||||||||||||||||||||||||||||||||
| Particular | Amount | |||||||||||||||||||||||||||||||
| Increase in contribution | $35,000.00 | |||||||||||||||||||||||||||||||
| Add: Reduce in salary | $20,000.00 | |||||||||||||||||||||||||||||||
| Profit before tax and depreciation | $55,000.00 | |||||||||||||||||||||||||||||||
| Less: Depreciation | $40,000.00 | |||||||||||||||||||||||||||||||
| Profit before | $15,000.00 | |||||||||||||||||||||||||||||||
| Less: Tax @ 20% | $3,000.00 | |||||||||||||||||||||||||||||||
| Profit after tax | $12,000.00 | |||||||||||||||||||||||||||||||
| Add: Depreciation | $40,000.00 | |||||||||||||||||||||||||||||||
| Cash flow after tax | $52,000.00 | |||||||||||||||||||||||||||||||
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Cash flow in 3rd year
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Present value = cash flow/(1+r)^n Here, r = rate of interest n= No of period In this question, r= 10% or 0.10
So, the Net present value = $134,125 - $116,000 = $18,125 The payback period
The payback period shall lie between 2 - 3 years, as $104,000 shall recover up to 2nd year and remaining of $ 16,000 will be recovered in a fraction of 3rd year |
So the payback period :
$16,000/58,400 = 0.27
So the period payback period is 2.27 years
So from the above discussion, the machine should be replaced as NPV is more than $5,000 and the payback period is less than 3 years
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