The Kitale Maize Mills is contemplating the purchase of a new high-speed grinder to replace an existing one. The existing grinder was purchased two years ago at an installed cost of Sh.300,000. The grinder was estimated to have an economic life of 5 years but a critical analysis of its performance now shows it is usable for the next five years with no resale value.
The new grinder would cost Sh.525,000 and require Sh.25,000 in installation costs. It has a five year usable life. The existing grinder can currently be sold for Sh.350,000 without incurring any removal costs. To support the increased business resulting from purchase of the new grinder, accounts receivable would increase Sh.200,000, inventories Sh.150,000 and trade creditors Sh.290,000. At the end of 5 years the new grinder would be sold to net Sh.145,000 after removal costs and before taxes. The company provides for 40% taxes on ordinary income. The estimated profit before depreciation and taxes over the five years for both machines are given as follows:
The company uses straight line method of depreciation for both machines.
a) Calculate the initial investment associated with the replacement of the existing grinder with the new one. Show your full workings.
b) Determine the incremental operating cash flows associated with the proposed grinder replacement.
c) Calculate the terminal cash flow expected from the proposed grinder replacement.
a) Net Book Value of old asset