The Merton Medical Business is considering replacing an old machine that cost the business \(\$ 100000\) five years ago. This machine could be used for 10 more years, at which time it would have no residual value. If it were sold now, net receipts from its disposal would be \(\$ 31250\). The old machine requires four operators to run it, each earning \(\$ 35000\) per year.

The new machine, which costs \(\$ 181250\), has an estimated life of 10 years and a residual value of \(\$ 7500\) at the end of that time. The new machine requires only three operators, each earning \(\$ 37500\) per year. Actual direct materials costs would be slightly less with the new machine because materials waste (currently \(\$ 5000\) per year) could be cut in half.

Maintenance on the old machine, which currently costs approximately \(\$ 3750\) per year, would be decreased by 40 per cent with the new machine. At present, power costs are \(\$ 25000\) per year. The new machine would require 5 per cent less power. Greenville estimates that the revenues associated with the product produced by the old machine, \(\$ 187500\) per year, would not be changed by purchasing the new machine. Merton Medical's required rate of return is 20 per cent. Required:

a Prepare a schedule of the relevant cash flows for this capital expenditure proposal to replace the old machine. Indicate any cash flows that are not relevant, and explain why they are not relevant.

b Calculate the net present value of the proposal. Is this proposal acceptable?

c What maximum amount should Merton Medical be willing to pay for the new machine?