Capital Budgeting

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Melchor Insurance is evaluating a new processor to prepare personalized reports for
insurance clients. Melchor will serve 200,000 clients per year for the foreseeable future.
The report is currently prepared on a three year old machine that could be used for
another five years. The machine cost P160, 000 new and was to last eight years. It is
now worth P 85,000 net of taxes, or it will have a P 15,000 salvage value net of taxes in
five years.
The new machine will have a useful life of five years, cost P275, 000 and have a P
25,000 salvage value net of taxes. Comparative cash operating expenses are:
Old Machine
Variable Cost
Fixed Cost

P 2.00 per client
P 100,000.00

New Machine
P 1.70 per client
P 80,000.00

Assume straight-line depreciation, a 40% tax rate, and a 14 % cost of capital.
Required:
1. Find the relevant cash flows for the machine replacement decision.
2. Using the NPV method, should the new machine be acquired?
3. Find the IRR, the payback period, and the ARR.

Melchor Insurance is evaluating a new processor to prepare personalized reports for
insurance clients. Melchor will serve 200,000 clients per year for the foreseeable future.
The report is currently prepared on a three year old machine that could be used for
another five years. The machine cost P160, 000 new and was to last eight years. It is
now worth P 85,000 net of taxes, or it will have a P 15,000 salvage value net of taxes in
five years.
The new machine will have a useful life of five years, cost P275, 000 and have a P
25,000 salvage value net of taxes. Comparative cash operating expenses are:
Old Machine
Variable Cost
Fixed Cost

P 2.00 per client
P 100,000.00

New Machine
P 1.70 per client
P 80,000.00

Assume straight-line depreciation, a 40% tax rate, and a 14 % cost of capital.
Required:
1. Find the relevant cash flows for the machine replacement decision.
2. Using the NPV method, should the new machine be acquired?
3. Find the IRR, the payback period, and the ARR.

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