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A Company is considering to replace an existing machine for which two suppliers have given quotation. Supplier A has proposed a machine costing Rs. 180 lakh that uses the existing boiler while supplier B has quoted for the machine Rs. 110 lakh but that requires modification in the existing energy supply system costing Rs. 30 lakh. The machines have a life of 10 years and can be sold for 5% and 10% of the original cost respectively for Suppliers A and B. The additional working capital requirement expressed as % of revenue are 20% and 25% respectively because of larger requirement of fuel for the machine from Supplier B.
The details are condensed below:
(Rs. in lakh)
Supplier A Supplier B
Price of machine 180 135
Annual Cash flows
Revenue 200 205
Operating cost 150 155
Working capital (% of revenue) 20% 25%
Salvage value % of cost 20% 5%
The firm charges depreciation on SLM basis with zero book value and has a tax rate of 35% for all kinds of income. The cost of capital for the firm is 12%
Which of the suppliers should the company prefer?
(a) as per NPV rule
(b) as per IRR rule.
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