Project II

Replacement Decision in Capital Budgeting

Group Members
Syed Saad Ali MPM 171014
Hammad Sabir MPM 171013
Naqeeb Farooqi MPM 171 .

Submitted to
Sir Nasir Rasool
Question No 1:
Comment on the companys process of for assessing capital budgeting ideas?
In Internal investment (capital Budgeting) are handled efficiently the usual sources of ideas for such
expenditure are the sale and marketing staff the company's cost accountants research and development
personals and the engineering or production staff in a company such as restore where in the
management structure is very economical, usually the cost accountant, top management and the
representative from the manufacturer major expenditure decision.

Question No 2:
Calculate compound growth rates for companys projected revenues and earnings?
Year Revenue Earning after tax (EAT)
1996 6000 440
1997 6900 464
1998 7866 538
1999 8445 652
8445 1/3 652 1/3
i=( ) 1 = 0.1206 i=( ) 1 = 0.14
6000 440
Compounded growth rate
12.06% 14%

Question No 3:
Evaluate the cash flows for the purchase of Automaster I and the replacement of the
original machine?
Probability Estimate Salvage Value
0.3 $5000 $1500
0.2 $7000 $1400
0.5 $6500 $3250
Total Salvage Value $6150

New Machine Depreciation = $60000 - $6150 = $53850

$53850
Annual Depreciation= = $6731.25
8
$24000
Old Machine Annual Depreciation = = $2400
10

Increase in Depreciation= $6731.25 - $2400 = $4331.25

 Initial outflow:
Cost of machine $ 60,000
+ Working Capital Required $ 2000
- Old machine Sold $15000
+ Additional tax due to gain on sold machine (30%) $4500
Total Cash outflow $51500

Future Cash flow:

Years 1 2 3 4 5 6 7 8
Increase in
$12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000
Revenue
Increase in
- $4331.25 $4331.25 $4331.25 $4331.25 $4331.25 $4331.25 $4331.25 $4331.25
Depreciation
EBT $7668.75 $7668.75 $7668.75 $7668.75 $7668.75 $7668.75 $7668.75 $7668.75
- Tax (30%) $2300.6 $2300.6 $2300.6 $2300.6 $2300.6 $2300.6 $2300.6 $2300.6
EAT $5368.1 $5368.1 $5368.1 $5368.1 $5368.1 $5368.1 $5368.1 $5368.1
+ Increase in
$4331.25 $4331.25 $4331.25 $4331.25 $4331.25 $4331.25 $4331.25 $4331.25
Depreciation
Net Cash
$9699.37 $9699.37 $9699.37 $9699.37 $9699.37 $9699.37 $9699.37 $9699.37
Flow
+ Salvage Value $6150
- Tax on Salvage $1845
+ Increase in WC 2000
$16004.3
Summary
Time Cash Flow
(years) ($)
0 (51500)
1 9699.37
2 9699.37
3 9699.37
4 9699.37
5 9699.37
6 9699.37
7 9699.37
8 16004.3

Question No 4:
Is there an economic justification for the replacement? Please explain your answer.
Discount Rate (i) = 8%
 1 2
= + +
1 + (1 + ) 2 (1 + )
According to above formula,
NPV= $7644.62
By considering average cost of funds to the company, the discount rate would be 8%. If company
replace of new machine, there will be increase in cost of capital of $7644.63. Which is beneficial for
company. Automaster 1 will also reduce labor force by approx. 20%.

Question No 5:
Should the original machine be replaced?
Yes, due to replacement of original machine, Company will get more profit.

Question No 6:
Comment upon the ethical and other aspects of the company's potential reduction of
its workforce?
Replacement of machine will decrease employment rate within geographic area. According to ethical
responsibility company should not reduce labor force. But if company does not adopt latest
technology for production the company will be thrown out from the market.
On the other hand, this strategy reduce high school dropout rate and lower the crime rate.

Question No 7:
What additional economies information would be useful in the replacement
decision?
Any increase or decrease in maintenance and repair cost
Any working capital required for replacement
Estimate Salvage value not based on probability
Discount rate for the investment by the company

Question No 8:
Assess the Schadles concern over the ethics question?
Schadler's concern over the ethical question is logical and justified as the major chunk of their
company's labor comes from the training programs which are also helpful in improving the social life
of the people. Since he is a major spokesperson for the program and most of the colleagues are
recruited there. It will be quite unethical and immoral to reduce the workforce for the short term
economic gains. But if he still reduces the workforce, then he might be questionable about the role in
the employment of the young people who arc benefited through the training programs and most of
their mentors are working voluntarily.
Question No 9:
Discuss the probability estimate of the new machine salvage value. Is it reasonable
that the manufacturer be involved in the decision process?
Although the probability estimates of new machine seems reasonable (the salvage value is equal to
the estimates) but this should have been made through an independent assessment rather than
manufacturers involvement.

Question No 10:
Consider the companys size (sales and assets) and its line of business-will
unforeseen obsolescence of Automaster I effect the potential replacement of the
machine?
Yes, given the balance sheet composition of the company and project revenues, an unforeseen
obsolescence will significantly impact the existence of the company.
Considering the business nature and size of the Restore incorporated, the investing of $60000 is not
a small amount. The machines and technology change rapidly which make difficult for the small
business to upgrade their technology and machinery accordingly.