Question 4 10 Marks

Delafono is evaluating replacing an old pasta-making machine that is expected not to last

more than two years. During that time, the machine is expected to generate a cash inflow of

R20,000 per year. It could be replaced by a new machine at the cost of R150,000. The new

machine is more efficient than the current machine, and as a result, it is expected to generate

a net cash flow of R75,000 per year for three years. The management of Delafono is

wondering whether to replace the old machine now or wait another year. Delafonos cost of

capital is 10 percent.

Required:

4.1. Assume that the current resale value of the old machine is zero and that the new

machine will also have a zero-resale value in the future. What is the annual equivalent

cash flow of using the new machine? (5)

4.2. What should the management of Delafono do? Explain. (5)