A lathe used for the purpose of cutting molded plastics was acquired 10 years ago for a totalexpenditure of RM7,500,000. At the time of acquisition, the machine was projected to have a lifespanof 15 years, and the management's initial estimation, which remains unchanged, posited that theresidual value would be negligible upon the completion of the aforementioned 15-year period. Themachine is subject to depreciation using the straight-line method, resulting in an annual depreciationexpense of RM500,000. As a result, the current book value of the equipment stands at RM2,500,000.According to the report provided by the R&D manager, there is a proposition to acquire a newspecialized machine at a cost of RM12,000,000, which includes expenses for freight and installation.This machine is projected to have a lifespan of five years and is expected to result in a reduction inboth labor and raw material consumption. Consequently, the annual operating costs are anticipatedto decrease from RM9,000,000 to RM4,000,000. The decrease in expenses will result in an increase inpre-tax profits of RM9,000,000 - RM4,000,000 = RM5,000,000 annually.According to estimates, the projected salvage value of the new equipment after a period of five yearsis RM2,000,000. The present market worth of the antiquated machine is RM1,000,000, which is lowerthan its book value of RM2,500,000. In the event of acquiring the new machine, the decision has beenmade to sell the old lathe to another company, rather than opting for an exchange with the newmachine. The marginal tax rate of the corporation is 40 percent, while the replacement project ischaracterized by a risk level slightly below the average. The net operating working capital requirementswill experience an increase of RM1,000,000 upon replacement. The newly acquired machine isclassified under the 3-year Modified Accelerated Cost Recovery System (MACRS) class (33%; 45%;15%; 7%). Additionally, due to the relatively assured nature of the cash flows associated with theproject, the project's cost of capital is determined to be 11 percent, which is lower than the 12 percenttypically assigned to projects with average risk. Explain the effect of inflation on the cash flows.
A lathe used for the purpose of cutting molded plastics was acquired 10 years ago for a total
expenditure of RM7,500,000. At the time of acquisition, the machine was projected to have a lifespan
of 15 years, and the management's initial estimation, which remains unchanged, posited that the
residual value would be negligible upon the completion of the aforementioned 15-year period. The
machine is subject to
expense of RM500,000. As a result, the current book value of the equipment stands at RM2,500,000.
According to the report provided by the R&D manager, there is a proposition to acquire a new
specialized machine at a cost of RM12,000,000, which includes expenses for freight and installation.
This machine is projected to have a lifespan of five years and is expected to result in a reduction in
both labor and raw material consumption. Consequently, the annual operating costs are anticipated
to decrease from RM9,000,000 to RM4,000,000. The decrease in expenses will result in an increase in
pre-tax profits of RM9,000,000 - RM4,000,000 = RM5,000,000 annually.
According to estimates, the projected salvage value of the new equipment after a period of five years
is RM2,000,000. The present market worth of the antiquated machine is RM1,000,000, which is lower
than its book value of RM2,500,000. In the event of acquiring the new machine, the decision has been
made to sell the old lathe to another company, rather than opting for an exchange with the new
machine. The marginal tax rate of the corporation is 40 percent, while the replacement project is
characterized by a risk level slightly below the average. The net operating working capital requirements
will experience an increase of RM1,000,000 upon replacement. The newly acquired machine is
classified under the 3-year Modified Accelerated Cost Recovery System (MACRS) class (33%; 45%;
15%; 7%). Additionally, due to the relatively assured nature of the cash flows associated with the
project, the project's cost of capital is determined to be 11 percent, which is lower than the 12 percent
typically assigned to projects with average risk.
Explain the effect of inflation on the cash flows.
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