4 Investment Decisions or Relevant Cash Flows

Rehman Company is contemplating the purchase of new high speed widget grinder to replace the existing grinder. The existing grinder was purchased 2 years ago at cost of Rs80,000; it was being depreciated under the straight line method. The existing grinder is expected to have a usable life of 3 more years.

The new grinder costs Rs150,000 and requires Rs5,000 in installation costs. New grinder has 3 years usable life and would be depreciated by straight line method. Company can currently sell the existing grinder for Rs40,000 without incurring any removal or cleanup costs. To support the increased business resulting form the purchase of new grinder, working capital requirements of a company would increase by Rs7, 000 and cost of training would be Rs5,000.

At the end of 3 years, the existing grinder is expected to have a scrap value of zero; the new grinder is expected to have scrap value Rs10,000 at the end of its life. The estimated incremental profit before depreciation and taxes or Annual Saving Rs80,000. Tax rate is 30 %.

Required:

1. Calculate the initial cash flows associated with the replacement of the existing grinder by the new one.
2. Determine the incremental operating cash inflows associated with the proposed grinder replacement.
3. Determine the terminal cash flows expected at the end of year 3 from the proposed grinder replacement.