ABC Ltd. can continue to use the three hand loaded machines for their remaining twelve years.
Alternatively, ABC Ltd. can replace the three hand-loaded machines with an automatic milling machine. The new machine would have the same capacity as the combined capacity of the three hand-loaded machines, would have a twelve year useful life and would have zero salvage value. Cost of the automatic milling machine is Rs.48, 00,000. The automatic machine would result in pre-tax labour savings, including benefits of Rs.13, 50, 000 per year. Other out-of-pocket cash savings were estimated at Rs.250, 000 per year, before taxes. Based on the charge made for each square meter of floor space, the machining department would save Rs.30,000 in the annual charge for space. No alternative use of space was anticipated.
If ABC Ltd. acquires the automatic milling machine, it will sell the three hand-loaded machines immediately for a total price of Rs.10, 00, 000.
No inflation is anticipated. ABC Ltd uses a discount rate of 9% to evaluate cost reduction projects.
Is the investment in the automatic milling machine economically attractive? Assume a 30% tax rate.
(i)What are the actual, after-tax cash flows for each of the two alternatives?
(ii)What is the net present value of the actual cash flows for each of the two alternatives? [continues]
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