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BMX Ltd. is considering the purchases of a new machine tool to replace an obsolete one. The machine being used has a tax book value
BMX Ltd. is considering the purchases of a new machine tool to replace an obsolete one. The machine being used has a tax book value of K17,000,000 and a market'value of K13,000,000. The machine is being depreciated at a charge of K1,300,000 per year over its remaining useful life of 10 years to a K4,000,000 salvage value. The proposed machine will perform the operation so much more efficiently that BMX engineers estimate that labour and other direct costs will be reduced by K14,000,000 per year if it is installed. Further, sales are expected to increase by K5,000,000 per year. The new machine will cost K53,000,000 delivered and installed and has a useful life of 10 years with K3,000,000 salvage value. The company expects to earn 12 percent on its investments after tax. The tax rate is 35 percent and the company uses straight line depreciation. Use the NPV, IRR and PI methods to determine whether BMX Ltd. should buy the new machine. What is the ARR of this machine? Comment on the relative strengths/weaknesses of the ARR method. (25 marks)
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