Primrose manufacturing has an old machine that is 2 years old and which it would like to replace with a brand new one that will cost the company R160 000. The new machine requires R4 000 shipping costs and R2 000 installation costs. The economic life of the new machine is 3 years with tax allowable depreciation of R75 000 for the first 2 years. If the new machine is acquired, the inventory will increase by R13 000, accounts receivable by R9 000 and accounts payable by R15 000. The new machine will result in sales revenue of R120 000 and cash operating costs of R23 000.
The current machine was purchased for R75 000 and is expected to last for 3 more years after which it will be worthless. The current machine provides sales revenue of R100 000 and cash operating cost of R20 000. Its current market value is R25 000.
The expected resale value of the old and new machine in 3 years' time would be R14 000 and R16 600 respectively. The corporate tax rate is 30%.
Required:
a. Calculate the initial investment associated with the proposed replacement decision
b. Calculate the incremental operating cash flows of the proposed replacement decision
c. Calculate the terminal cash flow associated with the proposed replacement decision
d. Calculate the NPV of the replacement project assuming a discount rate of 6% per annum
e. Use the computed NPV results an discuss the decision to accept or reject the project