Question
A firm is considering replacing its old machine with a
new one. Old machine: Book value = ₹8L, Salvage = ₹2L New machine: Cost = ₹20L, Life = 5 years Annual savings in operating cost = ₹6L Depreciation on new machine: Straight-line to zero Tax rate = 30%, Discount rate = 10% Should the firm go for replacement? (Use PVAF 10%, 5 years = 3.791)Solution
Annual savings after tax = ₹6L × (1 – 0.3) = ₹4.2L PV of inflows = ₹4.2L × 3.791 = ₹15.92L salvage from old = 2L taxed → tax = ₹(2 – 0) × 30% = ₹0.6L So net inflow from old = ₹2 – 0.6 = ₹1.4L Net investment = 20L – 1.4L (realized from old) = ₹18.6L NPV = ₹15.92 – ₹18.6 = –₹2.68L
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