Pietro Yon has been supplied with information from a component manufacturer who has asked for advice on the best project to accept for the purchase / replacement of a piece of machinery.

The company are considering selling their old machine that has a capital cost of £260 000 and replacing it with an up to date model costing £220 000. For immediate purchase the company will receive £120 000-part exchange allowance.

Both the current and new machines are able to meet the expected company demand, estimated at:

  Year   Units

   1      90 000

   2      50 000

   3      30 000

  

After three years, it is predicted that demand will be zero due to the technological developments in the industry.

The following data has been provided for the existing and new machine:

  

                                  Current Machine             New Machine 

                                       £ per unit                      £ per unit

 Direct Materials                 1.80                             1.80

 Direct Labour                    0.75                             0.60

Variable Overheads           0.45                             0.30

 Depreciation                     0.35                             0.55

 

   Additional information 

(1) The selling price for each component is £5.00 and this will remain constant for the next three years. 

(2) The company expect the cost of direct materials and direct labour to increase by 5% each year. 

(3) The company predicts that repair and maintenance costs for the current machine will be £7000 per annum. 

(4) The current machine is expected to have a zero-residual value at the end of year 3. 

(5) The company predicts that repair and maintenance costs for the new machine will be £1000 per annum. 

(6) The new machine is expected to have a £75 000 residual value at the end of year 3. 

The company's cost of capital is 15%

Extract from the present value table for £1 at 15%

  Yea             Units

   1               0.870

   2               0.756

   3               0.658

   4               0.572

  

Pietro would like you to produce a business report that can be given to the company offering advice on the best course of action for the purchase / replacement machine.

REQUIRED

A report that evaluates the capital expenditure proposals using appropriate financial techniques.