Premium Pie Company needs to purchase a new baking oven to replace an older oven that requires too much energy to run. The industrial size oven will cost RM1,200,000. The oven will be depreciated on a straight-line basis over its six-year useful life. The old oven cost the company RM800,000 just four years ago. The old oven is being depreciated on a straight-line basis over its expected ten-year useful life. (That is, the old oven is expected to last six more years if it is not replaced now.) Due to changes in fuel costs, the old oven may only be sold today for RM100,000. The new oven will allow the company to expand, increasing sales by RM300,000 per year. Expenses will also decrease by RM50,000 per year due to the more energy efficient design of the new oven. Premium Pie Company is in the 40% marginal tax bracket and has a required rate of return of 10%.

 

Required:

a.            Calculate the initial cash outflow associated with replacing the old oven with the new one?                                                                                                            

b.            Calculate the net present value if the company decided to buy the new oven? Should Premium Pie Company replace the old oven?

c.             Explain the impact on NPV if operating cost of new machine are increased.