Alpha company is trying to install a new machine that has estimated cost Rs. 200,000 by replacing an old machine. The ne

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Alpha Company Is Trying To Install A New Machine That Has Estimated Cost Rs 200 000 By Replacing An Old Machine The Ne 1 (220.23 KiB) Viewed 38 times

Alpha company is trying to install a new machine that has estimated cost Rs. 200,000 by replacing an old machine. The new machine required installation cost Rs. 20,000. The expected increase in working capital would be Rs. 25,000. The old machine was purchased 3 years ago and estimated that it would last for six years at the time of purchased. The current book and cash salvage value of the old machine is Rs. 40,000 and 60,000 respectively. The estimated book and cash salvage value of new machine at the end of year three would be Rs. 50,000 and 70,000 respectively. The cost of capital is 10% and risk premium is to be estimated 6%. Assume the probability distributions of cash flow for future period are independent. In order to accommodate probability distribution the company has adopted a policy to equal final year effects with investment cost. The expected incremental net cash flow and corresponding probabilities are as follows: Year 1 CFAT Rs 80,000 70,000 60,000 50,000 40,000 Required: 0 Probability 0.1 0.2 0.4 0.2 0.1 Year 2 CFAT Rs 70,000 60,000 50,000 40,000 30,000 Probability 0.1 0.2 0.4 02 0.1 Year 3 CFAT Rs stions 30,000 40,000 50,000 60,000 65,000 Probability 0.1 0.2 0.4 0.2 0.1 Should the company replace the existing machine? Probability of profitability index being less than 1.20. Ans: NCO = Rs. 10,990; NPV = Rs. 37,935.5; ONPV = 17,156.43 NPV = Rs. 21,998; 17.62%