Haw Par Industries (HPI) is a major supplier of herbs to all Chinese Medical Halls in the

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Question:

Haw Par Industries (HPI) is a major supplier of herbs to all Chinese Medical Halls in the country. It needs to purchase a new fully automated process line costing RM900,000.00. Modification to the equipment, shipping and freight insurance will costs another RM200,000.00. This proposed new equipment will be depreciated using straight-line depreciation towards an estimated RM100,000.00 salvage value over its 4-year project life.

If the proposed new equipment are purchased, it will replace the existing one purchased 4 years ago at an installed cost of RM400,000.00. The existing equipment, depreciated on a straight-line basis towards zero salvage value, will be worthless at the end of its 8 years useful life, but can be sold today for RM210,000.00.

HPI expects to increase its sales by RM345,000.00 but operating expenses will also increase by RM28,000.00. The increase in sales and operating expenses are expected to be constant during its project life. Net operating working capital is also expected to increase by RM35,000.00. This investment is expected to be fully recovered at the end of its project life.

HPI has already spent RM50,000.00 on consultancy work to conform with the requirements set by the Environmental Agency. The company cost of capital is 10% and is in the 30% tax bracket.

a) Should HPI proceed with the replacement? [Hint: Use the NPV & IRR criteria in your decision making]

b) What does it mean that only relevant cash flows should be included estimating cash flows? Explain your answer based on the information available in the above question and demonstrate with examples.