Reference no: EM133186967
Question - Sehzade Bhd is considering expanding its project and replacing its existing machine with a new machine from Istanbul, Turkey. The company intends to replace its AA3 machine with the new model AH5. The company's current annual sales are RM1,960,000. To buy this machine, Sehzade Bhd plans to take a long-term loan of RM1,300,000 and 5% interest will be paid annually. The balance will be financed by retained earnings. Non-current assets are depreciated using a straight-line basis. The corporate tax rate is 24% and the firm's cost of capital is 10%. The desired payback period is 5 years.
Existing machine - AA3 model
The existing machine was bought four years ago for RM1,200,000 with an expected useful life of 9 years. Its expected salvage value is RM120,000 and it can be sold today for RM750,000. The machine is currently handled by three operators, each earning RM36,000 per year. The annual maintenance cost is RM100,000.
New machine - AH5 model
The price of the new machine is RM1,560,000 (excluding of transportation, insurance during transit, and installation charges of RM100,000, RM140,000, and RM160,000, respectively). As part of the evaluation, the company paid a consulting firm RM50,000 to perform a test on marketing analysis. This new machine will increase the annual sales by 15% for the first two years and increase by RM350,000 in the remaining years. The annual maintenance cost is reduced to RM52,000. The use of the new machine will increase the firm's inventory by RM250,000 and an additional of short-term borrowings worth RM140,000 is required. Only one operator is required to handle the new machine. The service of the other two existing operators will be terminated and compensation of RM20,000 will be paid to each of them immediately. This new machine has a useful life of 6 years and no salvage value was assigned to this machine.
Note: Ignore inflation and taxation effect.
Required -
i. Calculate the following for model AH5 machine: a. Initial outlay b. Incremental cash flows over the project's life c. Terminal cash flows d. Payback period e. Net Present Value (Calculate to the nearest RM)
ii. Advise the management of Sehzade Bhd whether the company should proceed with the purchase of the new machine.