REVISION QUESTION 1: Capital budgeting STEEL MANUFACTURING wants to replace a three year old machine with a new one costing R2m. The new machine costs R400 000 to install and will be used for 5 years. Due to the more efficient production process it is expected that at the initial stage of the project inventory will decrease by R100 000 but accounts receivable will increase by R40 000. Working capital will not show any other movement over the term of the project. The old machine was originally purchased for R1m (3 years ago) and can be sold today for R100 000 but the machine is expected to last for 5 more years. The new machine will increase sales by R300 000 in the first year and reduce operating costs by R400 000 in the first year. It is expected that sales will increase by 10% per year (on the previous year) and the savings in operating costs will decrease by 5% per year (on the previous year). The estimated market value of the new machine after 5 years is R100 000. At the end of five years the old machine will have a zero market value, and will need to be removed at a cost of R10 000. Both machines qualify for four year straight-line depreciation, the tax rate is 28% and the firm's cost of capital is 12%. REQUIRED: Use the NPV, IRR and profitability index to determine whether the firm must replace the old machine or not. (Show all your calculations).