QUISTION ONE

M & M Pvt Ltd currently uses a tile making machine that was purchased six years ago. This

mac ine is being depreciated on a straight line basis towards a $$600000$ salvage value but it has

five ears of remaining life. Its current book value is $$2600000$ and it can be sold at $$260000$

at th soint in time. The company is offered a replacement machine, which has a cost of $$8000$

$000,$ an estimated useful life of ten years. It is estimated that its salvage value at the end of the

ten ears will be $$400000$ but will be sold for $$280000.$ The machine will also require $$100000$

for i to be installed. In addition, the replacement machine would permit an output expansion, so

that pales would rise by $$1500000$ per annum. The new machine is greater in efficiency such

that pperating expenses are expected to decline by $$950000$ per annum. In addition the machine

would require that inventories be increased by $$1300000$ and accounts payable would also

incr ase by $$820000.$ The company's effective tax rate is $30\%$ and its cost of capital is $25\%$ per

year Assume that depreciation is tax allowable.

Required:

i$)$ Compute the initial investment for M & M Pvt Ltd$.(8$ marks$)$

ii$)$ Calculate the after tax relevant cashflow for the company. $(9$ marks$)$

ii$)$ Determine the terminal cashflow for M & M Pvt Ltd $.(6$ marks$)$

iv$)$ Evaluate the proposed project using profitability index approach and advise the

company on whether to take it on board or not, giving reasons. $(12$ marks$)$

v$)$ What can possibly be drawbacks of using capital budgeting for decision making

purpose? $(5$ marks$)$