The following details relates to the two machines X and Y:
Machine X Machine Y
Cost
Estimated Life
Estimated salvage value
Working Capital required in the beginning Rs. 56,125 Rs.56,125
5 years 5 years
Rs. 3,000 Rs. 3,000
Rs.10,000 Rs. 20,000
Annual income after tax and depreciation:
Year Rs. Rs.
I 3,275 11,375
II 5,375 9,375
III 7,375 7,375
IV 9,375 5,375
V 11,375 3,375
Overhauling charges at the end of third year Rs. 25,000 on machine X. Depreciation has been charged at straight line method. Discount rate is 10%? P.V.F. at 10% for five years are 0.909, 0.826, 0.751, 0.683 and 0.621. Suggest which project should be accepted.
Please see your next post, which I saw first.
Sra
To determine which project should be accepted, we need to calculate the net present value (NPV) of each project.
1. Calculate the annual cash flows for each machine by subtracting the estimated salvage value from the annual income after tax and depreciation.
For Machine X:
Year I: 3,275 - 3,000 = 275
Year II: 5,375 - 3,000 = 2,375
Year III: 7,375 - (3,000 + 25,000) = -20,625 (Note: Subtracting the overhauling charges in the third year)
Year IV: 9,375 - 3,000 = 6,375
Year V: 11,375 - 3,000 = 8,375
For Machine Y:
Year I: 11,375 - 3,000 = 8,375
Year II: 9,375 - 3,000 = 6,375
Year III: 7,375 - 3,000 = 4,375
Year IV: 5,375 - 3,000 = 2,375
Year V: 3,375 - 3,000 = 375
2. Calculate the present value (PV) for each year's cash flow by multiplying the cash flow by the corresponding PVF.
For Machine X:
Year I: 275 * 0.909 = 249.975
Year II: 2,375 * 0.826 = 1,962.25
Year III: -20,625 * 0.751 = -15,506.875
Year IV: 6,375 * 0.683 = 4,354.125
Year V: 8,375 * 0.621 = 5,201.375
For Machine Y:
Year I: 8,375 * 0.909 = 7,620.375
Year II: 6,375 * 0.826 = 5,265.75
Year III: 4,375 * 0.751 = 3,282.125
Year IV: 2,375 * 0.683 = 1,623.625
Year V: 375 * 0.621 = 232.375
3. Calculate the NPV by summing up the present values of cash flows and subtracting the initial investment (working capital required).
For Machine X:
NPV = 249.975 + 1,962.25 - 15,506.875 + 4,354.125 + 5,201.375 - 56,125 = -59,864.15
For Machine Y:
NPV = 7,620.375 + 5,265.75 + 3,282.125 + 1,623.625 + 232.375 - 56,125 = -38,000.75
4. Compare the NPV of both projects and choose the project with a higher NPV. In this case, Machine X has a higher NPV which indicates a more favorable investment. Therefore, Machine X should be accepted over Machine Y.