A company wants to invest in a machinery that would cost - 50,000 at the beginning of year 1. It is estimated that the net cash inflows from…

CA Intermediate · Financial Management and Strategic Management · MTP · May 2026
A company wants to invest in a machinery that would cost - 50,000 at the beginning of year 1. It is estimated that the net cash inflows from operations will be - 18,000 per annum for 3 years, if the company opts to service a part of the machine at the end of year 1 at 10,000. In such a case, the scrap value at the end of year 3 will be - 12,500. However, if the company decides not to service the part, then it will have to be replaced at the end of year 2 at 15,400. But in this case, the machine will work for the 4 th year also and get operational cash inflow of 18,000 for the 4 th year. It will have to be scrapped at the end of year 4 at 9,000. Assuming cost of capital at 10% and ignoring taxes, will you RECOMMEND the purchase of this machine based on the net present value of its cash flows? If the supplier gives a discount of 5,000 for purchase, WHAT would be your decision? (The present value factors at the end of years 0, 1, 2, 3, 4, 5 and 6 are respectively 1, 0.9091, 0.8264, 0.7513, 0.6830, 0.6209 and 0.5644).

Suggested Answer and Working Notes:

Option 1: Purchase Machinery and Service Part at the end of Year 1. Net Present value of cash flow @ 10% per annum discount rate. NPV = -50,000 + (18,000 / (1.1)) + (18,000 / (1.1) 2 ) + (18,000 / (1.1) 3 ) - (10,000 / (1.1)) + (12,500 / (1.1) 3 ) = -50,000 + 18,000 (0.9091 + 0.8264 + 0.7513) – (10,000 × 0.9091) + (12,500 × 0.7513) = -50,000 + (18,000 × 2.4868) – 9,091 + 9,391 = -50,000 + 44,762 – 9,091 + 9,391 NPV = -4,938 Since, Net Present Value is negative; therefore, this option is not to be considered. If Supplier gives a discount of 5,000 then, NPV = +5,000 – 4,938 = +62 In this case, Net Present Value is positive but very small; therefore, this option may not be advisable. Option II: Purchase Machinery and Replace Part at the end of Year 2. NPV = -50,000 + (18,000 / (1.1)) + (18,000 / (1.1) 2 ) + (18,000 / (1.1) 3 ) - (15,400 / (1.1) 2 ) + (18,000 / (1.1) 4 ) + (9,000 / (1.1) 4 ) = -50,000 + 18,000 (0.9091 + 0.8264 + 0.7513) – (15,400 × 0.8264) + (27,000 × 0.6830) = -50,000 + 18,000 (2.4868) – (15,400 × 0.8264) + (27,000 × 0.6830) = -50,000 + 44,762 – (15,400 × 0.8264) + (27,000 × 0.6830) = -50,000 + 44,762 – 12,727 + 18,441 = -62,727 + 63,203 = +476 Net Present Value is positive, but very low as compared to the investment. If the Supplier gives a discount of 5,000, then NPV = 5,000 + 476 = 5,476 Decision: Option II is worth investing as the net present value is positive and higher as compared to Option I.

Topics: Part-A: Financial Management

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