Precision Engineers Ltd. Is considering a proposal to replace one of its
machines. The following data is available regarding the same:
a. The machine was purchased 4 years ago for Rs.15 lacs and has been
depreciated at 25% p.a. as per the WDV method. The machine has a
remaining life of 5 years, after which its salvage value is expected to be
Rs.0.80 lacs. Its present salvage value is Rs.6.0 lacs.
b. The new machine costs Rs.22lacs, and would be depreciated at 40% p.a. as
per WDV method. Its expected life is 8 years and after 5 years it is expected
to fetch Rs.6 lacs. The installation of this machine will increase the annual
revenue by Rs.5 lacs, apart from decreasing the operational costs by Rs.1.10
lacs per annum.
Assume no change in the depreciation rate if old machine is continued to be used.
If the company uses a discounting factor of 17% p.a. for calculating the present
value of future cash flow, should it go for the replacement of existing machine with
the new machine? Marginal tax rate of the company is 20%.
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