Page 188 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes Given cumulative present value of Re. 1 p.a. @ 10% for 5 years 3,791 and for 10 years 6,145

Solution:
Repairing existing machine 9,500

Cost of repairs is 19,000 net of tax
Equivalent annual cost for 5 years 9,500 ÷ 3.791 = 2506
Annual Running & Maint. cost for 10 years 10000

20,000 net of tax
Total annual cost 12506

Buying new machinery
Purchase cost 49000
Less: realization from old machine 5000

Annual equivalent cost for 10 years 44000/6145 7160
Running & Maint. cost per machine 14000/net of tax 7000

Tax benefit of depreciation p.a. 49000/10/× 50 (2450)
Total annual cost 11710
Difference in annual cost in buying 796

Since annual cost of buying is less than that of repairing, one should go for buying option.
Second solution:
1. To repair existing machine.

Cost of repair immediately net of tax. ( 19,000 × 50%) 9,500
Running & Maint. Cost of 5 years ( 20,000 × 3.791) 37,910
Total net present value of after tax cash outflows for 5 years. 47,410

Hence net equivalent cash outflows p.a. 47,410/3.791 12,506
2. To buy new machine

Purchase cost of new machine 49,000
Less: Sale proceeds of old machine 5,000 44,000
Tax benefit on depreciation p.a. ( 49000/10×50%) (2,450)

Running & Maint. Cost p.a. (50% of 14000) 7,000
Net cash outflow for 10 years ( 4550×6.145) 4,550 27,960

Net cash outflows for 10 years. 71,960
Hence net equivalent cash outflows p.a. 71,960/6.145 11,710
Since, net equivalent cash outflow p.a. for buying a new machine 11,710 is less than net
equivalent outflows of 12,506 for repairing of an existing machine. Therefore, it is advisable
that the company should go for buying a new machine.

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