Lotus corporation is contemplating replacing its existing milling machine with an improved version that would increase the production from 12,000 components per month to 18,000. Due to its improved design, the new components would also fetch a better price of TZS 105 as against existing price of TZS 85 per piece.
The new machine costs TZS 1,400,000 with an additional amount on installation and training of TZS 1,600,000 to be spent. If purchased, the existing milling machine would be sold for TZS 350,000 that has a book value of TZS 400,000. The remaining life of the existing machine is five years and the firm follows a policy of straight line method of depreciation of non-current assets. The life of the new machine too is 5 years.
Installing the new machine would entail some extra recurring cost. The operator’s salary would be increased from TZS 50,000 to TZS 70,000 per month. However, it would save the cost on maintenance and power. While the production would be increased by 50%, the rise in maintenance cost would be 20% from existing TZS 10,000 per month. Similarly, the power consumption would increase by 25% only from existing TZS 6,000 per month. There would be no change in any other cost. Any increase in working capital may be ignored.
Assuming 40% taxes and cost of capital 10%, examine whether Lotus corporation should buy the new milling machine or not