# Existing Machine (Matrix) 5 years old second hand machine. A competitor offered to purchase this machine at $35000. If the

## Question:

**Existing Machine (Matrix)**

5 years old second hand machine. A competitor offered to purchase this machine at $35000. If the machine was to be kept, depreciation is $6000 per year for five years. After five years the salvage value would be $5000. $28000 to be spent immediately for maintenance and repair and $7000 every year for the next five years. In year 3, the machine would require to be serviced for $4000.

**New machine (Delta)**

Cost of new machine is $135000 and a straight line depreciation of 10% per annum is allowed. The sales price after five years would be $60000. The company bought a maintenance plan for $2000 in the first year which increases by $1000 every year till year five. The loan to buy the machine is at 6% per annum which is to be repaid as interest only payments for five years, with the full principal repayable at the end of the loan period.

If the new machine is bought, there will be savings in labour and electricity costs. For labour, in the first year, savings is fore casted to be 10% (the existing rate is $30/hour, 35 hour/week, 50 week/year). This saving will increase by fixed $250/year.

For electricity, savings will be 10% as well. Current costs is $5.625/hour, 24 hours/day, 7 day/week, 50 week/year. This saving will increase by fixed $75/year.

** Questions**:

Using NPV analysis, should Magic Timber and Steel (Magic) purchase the new Delta finishing machine?

What other quantitative and/or qualitative factors(see below)need to be taken into consideration?

Sensitivity analysis (e.g., different discount rates, different selling prices, change in maintenance cost)

You may assume discount rate as 11% and tax rate as 30%.

Cash Flows:

Matrix: Salvage value, Repair, Maintenance, Scheduled service, Machine Sales

Delta: Machine investment, Labour savings, Electricity savings, Maintenance, Salvage value, Profit/Loss from sale

Non-Cash Flows:

Matrix: Depreciation (given in case)

Delta: Depreciation (10% per year of cost $135,000)

Tax Impact relevant Cash Flows:

Which of the above cash flows and non-cash flows could impact the cash flow for tax saving/payment?

•Savings (+ taxable income), Costs (-taxable income), Depreciation (Matrix, Delta), Profit/Loss from Sale

Cash Flows for NPV:

Which of the above cash flows (including tax impact relevant cash flows) are relevant for purchase of Delta decision?

**Related Book For**

## Financial Reporting Financial Statement Analysis and Valuation a strategic perspective

ISBN: 978-1337614689

9th edition

Authors: James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

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**Question Details**

**12**- Valuation: Cash-Flow-Based Approaches