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Investment Analysis for New Machine

XYZ Ltd is evaluating the replacement of an old machine with a new one, involving an initial investment of Sh. 506,000, which includes costs for the new machine, installation, and changes in working capital. The new machine is projected to generate annual operating cash flows of Sh. 159,000 over five years and a terminal cash flow of Sh. 134,000 at the end of its useful life. The analysis includes considerations for tax implications and depreciation.

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3 views3 pages

Investment Analysis for New Machine

XYZ Ltd is evaluating the replacement of an old machine with a new one, involving an initial investment of Sh. 506,000, which includes costs for the new machine, installation, and changes in working capital. The new machine is projected to generate annual operating cash flows of Sh. 159,000 over five years and a terminal cash flow of Sh. 134,000 at the end of its useful life. The analysis includes considerations for tax implications and depreciation.

Uploaded by

debra.projects2025
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

XYZ Ltd is considering replacing an old machine with a new one to improve efficiency and

reduce operating costs. The following information relates to the proposed investment:

1. Initial Investment Details:

 The new machine will cost Sh. 500,000.


 Installation of the new machine will cost an additional Sh. 50,000.
 The old machine will be sold for Sh. 100,000. Its current book value is Sh. 80,000.
 The company’s corporate tax rate is 30%.
 An additional Sh. 50,000 will be required as an increase in net working capital.

2. Operating Cash Flows:

 The new machine is expected to generate annual savings of Sh. 300,000 from improved
efficiency.
 The annual operating costs (cost of sales) related to the new machine are expected to
be Sh. 120,000.
 The machine will be depreciated on a straight-line basis over 5 years, with no salvage
value.

3. Terminal Cash Flow (End of Year 5):

 At the end of its useful life (5 years), the machine is expected to be sold for Sh. 120,000.
 The working capital invested at the beginning of the project will be fully recovered.

Required:

a) Calculate the Initial Investment required for the project.


b) Estimate the annual operating cash flows over the 5-year period.
c) Compute the Terminal Cash Flow at the end of year 5.

Solution✅ a) Initial Investment

Format:

Description Sh.

Cost of new asset 500,000

Installation cost 50,000


Description Sh.

Installed cost of new asset 550,000

Proceeds from sale of old asset (100,000)

Add: Tax on sale of old asset (20,000 × 30%) 6,000

After-tax proceeds from sale of old asset (94,000)

Add: Change in Net Working Capital 50,000

Initial Investment 506,000

✅ b) Operating Cash Flows (Years 1–5)

Method 1: Traditional Format

Description Sh.

Incremental sales (savings) over the life of the project 300,000

Less: Cost of sales (120,000)

Savings before depreciation and tax 180,000

Less: Depreciation (110,000)

Savings before tax 70,000

Less: Tax (70,000 × 30%) (21,000)

Savings after tax 49,000

Add back: Depreciation 110,000

Net Incremental Cash Flows 159,000 (per year for 5 years)

OR Method 2: Alternative Format


Description Sh.

Savings before depreciation and tax 180,000

Less: Tax (180,000 × 30%) (54,000)

Savings after tax 126,000

Add: Depreciation tax shield (110,000 × 30%) 33,000

Net Incremental Cash Flows 159,000 (same result)

✅ c) Terminal Cash Flows (End of Year 5)


Description Sh.

Proceeds from sale of new asset 120,000

Less: Tax on sale (120,000 × 30%) (36,000)

Net proceeds from sale 84,000

Add: Recovery of Net Working Capital 50,000

Terminal Cash Flow 134,000

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