Case Analysis

Of
Mechanical Drying
Equipment

Submitted to :
Prof. KK Vohra

Submitted By:

Abhinav Gupta(81001)
Aman Malhotra(81004)
Kedar Kulkarni(81029)
Vijay Pal(81061)
Mechanical Drying Equipment
Case Facts:
The Industrial Manufacture Ltd. has recently come up with more efficient drying equipment
& Pitamber Cement Company which is using a Old Drying Equipment in its Manufacturing
operations is forced to evaluate 3 following alternative
1. Carry on with the same Old Equipment till its useful life
2. Go for Overhauling of the old equipment
3. Go for new equipment & sell the old equipment.
Company usually uses SLM of depreciation.
New Drying Equipment:

 Annual operating cost = Rs. 10 lakh

 Useful life = 12 yrs
 Salvage Value = 10% of the Original cost at the end of useful life
 Depreciation allowed = 25 % WDV
 Time period of Delievery & Start up of Equipment from the date of Order = 12
months
 Installation cost = Rs. 15 lakh (Payable at the time of Start up )
 Equipment Cost = Rs 65 Lakh (50% payment at the time of order & 50% at the time
of start up )
Old Drying Equipment:

 Historical cost = Rs 25 lakh

 Installation cost = Rs 10 lakh
 Annual Current Operating cost = Rs 28 lakh
 Current selling price = Rs 4 lkah
 Salvage value = Rs 2 lakh
 Economic life = 8 yrs
Overhauled Drying Equipment:

 Overhauling cost = Rs 25 lakhs

 Exteded life after overhauling = 5 years
 Annual Operating cost after overhauling = Rs 22 lakh
 Salvage value = Rs 3 lakh
Note:

 Of the total operating Cost 80% is the cost of fuel. The general inflation rate is 6% per
annum while the fuel price could rise as much as 10% per annum
  The company intend to use Straight line method of depreciation however it would be
allowed 25% written down value depreciation for the purpose of depreciation. And
the company pays corporate income tax at 35%.

Case Analysis:

INPUT DATA
Old New Net
Purchase Cost 2500000 6500000
Annual Operating Cost 2800000 1000000
Reduction in operating costs 1800000
Installation Cost 1000000 1500000
Salvage Value 200000 650000
Current Market Value 400000 6500000
Old machine's current book value 1637500
Tax rate 35%
WACC 10%

DEPRICIATION

WDV 25%
SLM 287500

Now we will analyse the costing of the machine the company will incur in three cases :

1. Buying a new machine

2. Keeping the old one
3. Overhauling of the old one

Asumptions :

1. The variable cost (80%) is the fuel cost only which will by 10% on yearly basis.
 ECONOMIC
ANNUITY VALUE -
NEW MACHINE

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Purchase Cost 325000 325000 0 0 0 0 0 0 0 0 0 0 0
0 0
Installation Cost 0 150000 0 0 0 0 0 0 0 0 0 0 0
0
Operating cost 0 800000 880000 968000 1064800 117128 128840 1417249 1558973. 1714871 1886358. 207499 2282493
(Variable) 0 8 7 2 4
Operating Cost 200000 200000 200000 200000 200000 200000 200000 200000 200000 200000 200000 200000
(Fixed)
Operating Cost 100000 1080000 116800 1264800 137128 148840 1617249 1758973. 1914871 2086358. 227499 2482493
(Total) 0 0 0 8 7 2 4
Net Cash Flow 325000 575000 1080000 116800 1264800 137128 148840 1617249 1758973. 1914871 2086358. 227499 2482493
0 0 0 0 8 7 2 4
Salvage Value 650000

WACC 6% 16%
NPV 20278926 14345105
Annuity Factor 8.3838 5.1971
EAV 2418823 2760213
 OLD MACHINE

Salvage Value 400000 360000 320000 280000 240000 200000

Operating cost (Variable) 560000 560000 560000 560000 560000 560000
Operating Cost (Fixed) 2240000 2464000 2710400 2981440 3279584 3607542.4
Operating Cost (Total) 2800000 3024000 3270400 3541440 3839584 4167542.4
One Year carrying cost 6056000 6537440 7067264 7650310.4 8291901.44
4629594.94

OLD MACHINE    
(OVERHAULED
)
Capital Expenditure 250000 0 0 0 0 0 0 0 0 0 0
0
Operating cost (Variable) 440000 440000 440000 440000 440000 440000 440000 440000 440000 440000 440000
Operating Cost (Fixed) 176000 193600 2129600 234256 2576816 2834497. 3117947. 3429742 377271 4149987. 4564986.7
0 0 0 6 4 6 9
Operating Cost (Total) 220000 237600 2569600 278256 3016816 3274497. 3557947. 3869742 421271 4589987. 5004986.7
0 0 0 6 4 6 9
Salvage Value 400000 390000 380000 370000 360000 350000 340000 330000 320000 310000 300000
One Year carrying cost 739200 512156 5539136 599853 6503923 7059914. 7671566. 8344443 908466 9898973.
0 0 0 8 3 7 9

From the above analysis & working, we recommend that we should go for new machine option.