THE QUESTION IS BELOW

Sphynx Itd. is considering replacing its existing machine because the existing machine had a fault. The existing machine had a life of 5 years; was purchased one year ago for 5 lakhs and has been depreciated on a written down value basis at 10% p.a. The new machine to be purchased for Rs. 10 lakhs and has a life of 4 years and zero scrap value. If the old machine is sold at present, 2.5 lakhs can be recovered. The PBDT (Profit before depreciation and tax) will be Rs. 1.2 lakhs p.a. for 4 years. The new machine will require initial working capital investment of Rs. 1 lakh and further 1 lakh at the end of the second year. Depreciation would be on the basis of 10% p.a on written down value basis. The company also has another alternative, instead of buying a new machine, the company can repair the existing machine. The repair would cost the company Rs. 1 lakh (for taxation and depreciation purpose the repair is treated as capital expenditure and added to the value of asset). This would enable the old machine to provide PBDT of Rs. 90,000 annually for the remainder of its life. Also, there would be a need for further investment of Rs. 1 lakh in the form of working capital at the end of third year. The scrap value of the old machine after 4 years will be zero. Tax rate applicable is 30% and cost of capital is 10%. Required: On the basis of NPV, recommend whether the company should replace the machine or not