Santra Ltd. is planning to replace an old lathe machine with a new one. The production manager has shortlisted the two alternative types of lathe machines, and provided the following information: Particulars Alternative

CS Professional · Financial, Treasury and Forex Management · PYQS · June 2018
Santra Ltd. is planning to replace an old lathe machine with a new one. The production manager has shortlisted the two alternative types of lathe machines, and provided the following information: Particulars Alternative I Alternative II Name of supplier Apple Ltd. Grapes Ltd Cost of machine ₹100 lakh ₹50 lakh Resultant savings in cost Year 1 ₹10 lakh ₹20 lakh Year 2 ₹35 lakh ₹20 lakh Year 3 ₹25 lakh ₹20 lakh Year 4 ₹40 lakh ₹20 lakh Economical life in years 4 4 You are required to suggest which lathe machine to be purchased, by using the discounted payback period method, and considering the applicable discount rate of 10%.

Answer & Explanation:

Particulars PVIF 10% Alternate I (₹ in lakh) PV of Alternate I (₹ in lakh) Cum PV Alternate I (₹ in lakh) Alternate II (₹ in lakh) PV of Alternate II (₹ in lakh) Cum PV Alternate II (₹ in lakh) Name of supplier Apple Ltd. Grapes Ltd. Cost of machine (₹ in lakh) ₹100 lakh (100) (100) ₹50 lakh (50) (50) Resultant savings in cost (₹ in lakh) Year 1 0.9091 ₹10 lakh 9.091 (90.909) ₹20 lakh 18.182 (31.818) Year 2 0.8264 ₹35 lakh 28.924 (61.985) ₹20 lakh 16.528 (15.29) Year 3 0.7513 ₹25 lakh 18.7825 (43.2025) ₹20 lakh 15.026 (0.264) Year 4 0.6830 ₹40 lakh 27.32 (15.8825) ₹20 lakh 13.66 13.396 Economical life (in years) 4 4 Discounted payback period = 3 + (0.264 / 13.396) = 3.019 years Decision: Alternative II, to purchase from Grapes Ltd. should be chosen as the discounted payback is near 3 years, while in Apple Ltd.; the money could not be recovered over the economic life of the machine.

Topics: Capital Budgeting

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