The main cutting machine of Gawain Wilkins Ltd needs to be replaced. A replacement machine will cost S300,000. 

The current machine cuts 40,000 units a year. The number of units cut is expected to be reduced by 10 percent in year 1 due to the time taken to install the new machine. The number of units cut is expected to increase to 42,000 units for both year 2 and year 3. respectively. 

Additional information: 

• The cost of capital is 10 percent. 

• The following is an extract from the present value table for $1. 

• It is assumed that revenues are received and costs are paid at the end of the year. 

• Each unit of production costs $12 to manufacture. 

• Each unit is expected to sell for $15 in years 1 and 2, increasing by 5 percent in year 3. 

• It is assumed that everything produced is sold. 

Required

a. Calculate the annual net cash flows for each year, which are expected to result from the purchase of the machine. 

b. Using the expected annual net cash flows, calculate the NPV for the replacement machine. 

c. State whether or not the managers of Gawain Wilkins Ltd should purchase the machine. Give reasons for your answer.

Transcribed Image Text:

10% Year 1 0.909 Year 2 0.826 Year 3 0.751