Summary CAPITAL BUDGETING QUESTION

KCA UNIVERSITY
BCOM
BY
STEPHEN ODHIAMBO




QUESTIONS ON CAPITAL BUDGETING


QUESTION ONE : Estimating Cash Flows for a Replacement Decision
TPL Corporation is trying to decide whether it should replace a manually operated machine with
a fully automatic version of the same machine. The existing machine, purchased ten years ago,
originally cost KShs. 770,000. It is being depreciated on a straight-line basis over fifteen years
and is expected to have a salvage value of KShs. 20,000 in five years’ time. It’s current market
value is KShs. 20,000.


The proposed machine would cost KShs. 320,000. Freight and installation charges are expected
to be KShs. 20,000. It is expected to have a five-year useful life and a salvage value of KShs.
100,000 at the end of its life. This machine would require general servicing at the end of the third
year, which is expected to cost KShs.100, 000. The cost of servicing will be fully expensed.


Annual operating costs are expected to be KShs. 75,000 lower over each of the next five years if
the new machine is installed. The current level of sales is KShs. 360,000 per annum. With the
new equipment, the annual sales level is expected to be KShs. 390,000.


Johnson’s current tax rate is 40% and it will continue to use straight-line depreciation. Its cost of
capital is 12%. Using the net present value method, determine whether Johnson should purchase
the new machine.


QUESTION TWO




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