FASTER Ltd. Intends to replace a can-sealing machine with a new one which the management believes to be more efficient. The old machine was purchased three years ago and has three more years of economic life with a salvage value of Sh.850,000 at the end of this useful period.

Additional information:

1. The current net book value of the old machine is Sh.2,950,000 while its current market price is Sh.3,700,000.
2. The new machine costs Sh.11,000,000 and has a useful working life of three years. It is estimated to have a salvage value of Sh.3,500,000.
3. Purchase of the new machine would result in the following changes:

• Sales would increase by Sh.1,200,000 per annum
• Expenses would decrease by Sh.1,800,000 per annum.
• Stocks and creditors would increase by Sh.3,000,000 and Sh.1,000,000 respectively in the first year of the new machines working life. However, in the final year of the machines usage, stocks and creditors would decrease by Sh.3,000,000 and Sh.1,000,000 respectively.

4. The cost of capital is 12%.
5. Corporation tax rate is 30%.

Required:

Using suitable computations, advise the management of FASTER Ltd. on whether the old machine should be replaced. (10 marks)