Advanced: Timing of replacement decision XYZ pic uses 10 very old injection moulding machines, which are of a type which are no longer obtainable. It is proposed that they be replaced by 4 ‘new model’ machines with the same total capacity.

The old machines have a further life of 3 years and will have no salvage value at that time - the present salvage value averages £5000 per machine. Annual operating costs are £10000 per machine.

Each new machine, which has a life of 7 years, costs £52 000 and is expected to have an end of life scrap value of £4000. Total annual operating costs are £15 000 per machine.

The 6 operators who would be released follow¬ ing replacement of the old machines would be redeployed within the firm thereby saving some additional external recruitment.

There is the possibility that the installation of the new machines would entail modifications, cost¬ ing £60 000, to the factory building.

An appropriate discount rate suitable for the appraisal of all cash flows relevant to this decision is 12%.

Required:

Ignoring the possibility of modifications to the factory building determine whether the old machines should be replaced now or operated for a further 3 years.

Indicate how the costs of modifying the factory building should be included in the analysis.

Specify any assumptions and outline the deficiencies inherent in your analysis. Taxation may be ignored. (12 marks)

ACCA Level 3 Financial Management