Problem
I. Sri Mangir Sdn Bhd is producing palm oil for domestic use. The company's executive chairman, Syed Makrif Syed Joned plans to expand its markets by exporting palm oil to Arab countries. To realize his dream, new oil processing machinery should be purchased to replace the old machine. Below is information for both of these machines.
Old machinery
Cost (RM100,000)
Current sales price (RM30,000)
The life expectancy of the machine (10 years)
Salvage value at the end of the year-10 (RM0)
Depreciation expense (RM 10,000 annually)
The remaining lifetime of the machine. (5 years)
Depreciation methods (Simplified straight-line method)
The life expectancy of the project (10 years)
New Machinery
Cost (RM140,000)
Current sales price (at the end of Year 5). (RM60,000)
Salvage value at the end of year-20 (RM0)
The life expectancy of the machine. (7 years)
The life expectancy of the project. (5 years)
Depreciation expense (RM 20,000 annually)
Depreciation methods Simplified straight-line method
II. The new processing engine is expected to generate new revenue of RM45,000 a year. Net working capital is expected to increase to RM12,500. Engine maintenance costs will decrease by RM6,700 per year and increased operating costs of RM18, 300 a year. Assume that the required rate of return for the replacement project is 12% and a corporate tax rate is 28%.
i. Calculate the initial investment of this project
ii. Calculate the annual cash flows of the project from years 1-4
iii. Calculate the terminal cash flow of this project.
iv. Calculate the net present value (NPV) projects.
v. Is the old machine should be replaced with a new machine? Why?