Topsider Inc. is considering the purchase of a new leather-cutting machine to replace an existing machine. The old machine is bought 5 years ago for RM20,000 and still has a remaining economic life of 3 years. The salvage value after 3 years is RM3,000. It can be sold for RM9,000 today. The estimated revenue for the next 3 years for old machine is:
Year Old Machine
1 RM15,000
2 RM15,000
3 RM15,000
However, to replace the old machine, Topsider has 2 options to choose from; Cutting Machine A and Cutting Machine B. Information about these 2 machines can be found below:
Cutting Machine A
The machine costs RM 26,000. Because of new sales, we will increase our inventory by RM10,000, our account receivable by RM15,000 and account payable by RM7,800. The machine has a 3-year life and salvage value of RM4,100. Transportation cost is estimated at RM5,000. The operating costs will rise RM1,000 per year.
Cutting Machine B
The machine costs RM 32,000. Because of new sales, we will increase our inventory by RM15,000, our account receivable by RM19,000 and account payable by RM10,000. The machine has a 3-year life and salvage value of RM6,500. Transportation is estimated at RM9,000. The operating costs will rise RM2,000 per year.
The estimated revenues for the next 3 years for each new machine:
Year Cutting Machine A Cutting Machine A
1 RM24,000 RM25,000
2 RM26,000 RM30,000
3 RM30,000 RM45,000
Additional information:
The Marginal tax rate = 34%
Required rate of return = 12 %
Using simplified straight-line deprecation
Calculate the following cash flow for the Cutting Machine A and for the Cutting Machine B:
a) The initial Outlay in Year 0.
b) The annual cash flows for Year 1-3.
c) The terminal value in Year 3.
d) The NPV.
e) Which machine to choose based on your answer in (d)?