1.

Teja International is determining the cash flows for a project involving replacement of
an old machine by a new machine. The old machine bought a few years ago has a
book value of ₹500000 and it can be sold to realise a post-tax salvage value of
₹900000. It has a remaining life of five years after which its net salvage value is
expected to be ₹200000. It is being depreciated annually at a rate of 25% under the
WDV method.
The new machine costs ₹3000000. It is expected to fetch a net salvage value of
₹1500000 after five years. The depreciation rate applicable to it is 25% WDV
method. The new machine is expected to bring a saving of ₹650000 annually in
manufacturing costs (other than depreciation). The incremental working capital
associated with this machine is ₹500000. The tax rate applicable to the firm is 30%.
a. Estimate the cash flow associated with the replacement project.
b. What is the NPV of the replacement project if the cost of capital is 14%?

2. Mahima Enterprises is considering replacing an old machine by a new machine. The

old machine bought a few years ago has a book value of ₹ 90000 and it can be sold
for ₹90000. It has a remaining life of five years after which its net salvage value is
expected to be ₹10000. It is depreciated annually at the rate of 20% as per the WDV
method.
The new machine costs ₹ 400000. It is expected to fetch a net salvage value of
₹25000 after 5 years. It will be depreciated annually at the rate of 25% as per the
WDV method. Investment in working capital will not change with the new machine.
The tax rate for the firm is 35%. Estimate the cash flows associated with the
replacement proposal, assuming that other costs remain unchanged.

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 (a) A. Initial outlay (Time 0)

i. Cost of new machine Rs. 3,000,000

ii. Salvage value of old machine 900,000
iii Incremental working capital requirement 500,000
iv. Total net investment (=i – ii + iii) 2,600,000

B. Operating cash flow (years 1 through 5)

Year 1 2 3 4 5

i. Post-tax savings in
manufacturing costs 455,000 455,000 455,000 455,000 455,000

ii. Incremental
depreciation 550,000 412,500 309,375 232,031 174,023

iii. Tax shield on

incremental dep. 165,000 123,750 92,813 69,609 52,207

iv. Operating cash

flow ( i + iii) 620,000 578,750 547,813 524,609 507,207

C. Terminal cash flow (year 5)

i. Salvage value of new machine Rs. 1,500,000

ii. Salvage value of old machine 200,000
iii. Recovery of incremental working capital 500,000
iv. Terminal cash flow ( i – ii + iii) 1,800,000

D. Net cash flows associated with the replacement project (in Rs)

Year 0 1 2 3 4 5
NCF (2,600,000) 620,000 578,750 547,813 524,609 2,307,207

(b) NPV of the replacement project

= - 2600000 + 620000 x PVIF (14%,1) + 578750 x PVIF (14%,2)

+ 547813 x PVIF (14%,3) + 524609 x PVIF (14%,4) + 2307207 x PVIF (14%,5)
= - 2600000 + (620000 x 0.877) +(578750 x 0.769) +( 547813 x 0.675)
+( 524609 x 0.592) +( 2307207 x 0.519)
= - 2600000 + 543740 + 445059 + 369774 + 310568 +1197440 = 266,581

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