This document compares the costs and benefits of replacing an existing machine with a new machine over a 10 year period. It provides the book values, costs, useful lives, depreciation amounts, salvage values, and operating costs of both the existing and new machines. It then calculates the annual savings in operating costs, taxes, and net savings from replacing the machine. Adding the depreciation amounts results in the annual cash flows. The net present value and internal rate of return are calculated to determine if replacing the machine is financially favorable.

1. Case 11.1: Ritesh Foundaries Limited
Existing New
machine machine
Book value 35,000 -
Cost - 1,800,000
Useful life 10 10
SL depreciation 3,500 180,000
Current salvage value 75,000 -
Salvage value after 10 years 125,000 180,000
Annual op. cost 600,000 250,000
Inflation rate 5%
Risk-free rate 6%
Risk premium 7%
Risk premium (replacement) 4%
Discount rate (replacement) 5% + 6% + 4% 15%
Tax rate 35%
New vs. Existing
0 1 2 3 4 5
Savings in op. cost 337,500 324,375 310,594 296,123 280,930
Less: depreciation 176,500 176,500 176,500 176,500 176,500
Taxable savings 161,000 147,875 134,094 119,623 104,430
Less: tax 56,350 51,756 46,933 41,868 36,550
Net savings 104,650 96,119 87,161 77,755 67,879
Plus: depreciation 176,500 176,500 176,500 176,500 176,500
Cash flow 281,150 272,619 263,661 254,255 244,379
Cash outlay:
Cost of new machine -1,800,000
Less: after-tax salvage value of existing 61,000
-1,739,000
Salvage value of new (after-tax)
Less: salvage value of existing (after-tax)
Net cash flows -1,739,000 281,150 272,619 263,661 254,255 244,379
NPV -482,058
IRR 6.8%

2. 6 7 8 9 10
264,976 248,225 230,636 212,168 192,776
176,500 176,500 176,500 176,500 176,500
88,476 71,725 54,136 35,668 16,276
30,967 25,104 18,948 12,484 5,697
57,509 46,621 35,188 23,184 10,580
176,500 176,500 176,500 176,500 176,500
234,009 223,121 211,688 199,684 187,080
117,000
-81250
234,009 223,121 211,688 199,684 222,830