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Calculate the terminal cash flows in year 6

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Reference no: EM132538807

The Tanamera Toy Corporation (TTC) currently uses an injection moulding machine that was purchased 3 years ago. This machine has 5 years of remaining life. The machine was initially purchased at a cost of RM400,000. The current market value of the machine is estimated at RM260,000.

TTC is offered a replacement machine at a purchase price of RM340,000, with an estimated useful life of 6 years, and salvage value of RM15,000. However, to have the machine ready to be operated, TTC needs to install a cooling coil at a cost of RM50,000. This replacement machine would permit an output expansion, so that sales would rise by RM55,000 per year. The new machine's much greater efficiency would also cause the operating expenses to decline by RM10,000 per year. This new machine, however, would require that inventories be increased by RM150,000, and accounts payable would simultaneously increase by RM100,000.

Having heard about the efficiency of this new machine and in considering the replacement of the current machine, TTC hired an outside technical consultant to do a industrial survey on the machine's capability. This had cost TTC a fee of RM75,000.

TTC adopts a simple straight-line depreciation method for financial reporting purposes. The corporate tax rate is 25 percent.

a. How much is the net cost (initial outlay) to replace the injection moulding machine today?

b. How much will be the annual after-tax operating cash flows in Year 1 until 6?

c. Calculate the terminal cash flows in Year 6 (at the end of the useful life of the machine).

d. If TTC's cost of capital for this type of project is 15 percent, calculate the NPV of this replacement. Should TTC proceed with this replacement idea?

e. Calculate the payback period for this replacement project. If the management has set a maximum acceptable payback period of 3 years for this project, should TTC proceed with this replacement idea based on this payback criterion?

f. Based on the answers in (d) and (e), should TTC proceed with this replacement project? Explain your answer.

Reference no: EM132538807

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