Question

Jones Ltd. a food manufactureris considering purchasing a new machine for £275,000. The company is expectingan annual cash inflow of £85,000 from the sale of products and an annual cashoutflow of £12,500 for each of the six years of the machine’s useful life. Theannual cash outflows do not include annual depreciation charges for themachine. The machine is depreciated using the straight-line method. The machineis expected to last for six years, with a residual value estimated to be at therate of 15% of the original cost of the machine. The cost of capital for JonesLtd. is 12%.

Answer 1

Purchase Cost = PC = £ 275, 000
Let us say that the company takes a load of this amount and starts manufacturing and sales of products.

Depreciation cost of machine per year = (100 - 15)/(6*100)  * PC
  DC = £ 85*2750/6 = 38, 958.33
 CO = cash outflow  = £ 12, 500
Cost of Capital = COC = £ 12% of PC =  £ 33, 000

Net Debit at the end of each year = £ (38, 958.33 + 12, 500 + 33, 000)
               = £ 84, 458.33
Cash Inflow at the end of each year: £ 85, 000

Net profit each year :    £ 541.67
Net asset value of the purchased machine at the end of 6 years: 15% PC
        = £ 41, 250
This will be a good proposition for the company to take up.