Case Analysis

Of
Mechanical Drying Equipment

Submitted to :
Prof. KK Vohra
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
32500 32500
Purchase Cost 00 00 0 0 0 0 0 0 0 0 0 0 0
Installation 15000
Cost 0 00 0 0 0 0 0 0 0 0 0 0 0
Operating cost 80000 88000 96800 10648 11712 12884 14172 155897 171487 188635 20749 22824
(Variable) 0 0 0 0 00 80 08 49 3.7 1 8.2 94 93
Operating Cost 20000 20000 20000 20000 20000 20000 20000 20000 20000
(Fixed) 0 0 0 0 0 0 0 200000 200000 200000 0 0
Operating Cost 10000 10800 11680 12648 13712 14884 16172 175897 191487 208635 22749 24824
(Total) 00 00 00 00 80 08 49 3.7 1 8.2 94 93
32500 57500 10800 11680 12648 13712 14884 16172 175897 191487 208635 22749 24824
Net Cash Flow 00 00 00 00 00 80 08 49 3.7 1 8.2 94 93
65000
Salvage Value 0

WACC 6% 16%
2027892 1434510
NPV 6 5
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

3607542.
Operating Cost (Fixed) 2240000 2464000 2710400 2981440 3279584 4
4167542.
Operating Cost (Total) 2800000 3024000 3270400 3541440 3839584 4

4629594.
7650310. 8291901. 94
One Year carrying cost 6056000 6537440 7067264 4 44
OLD
MACHINE
(OVERHAU
LED)

25000
Capital Expenditure 00 0 0 0 0 0 0 0 0 0 0
44000 44000 44000 44000 44000 44000 44000
Operating cost (Variable) 0 0 0 0 0 440000 440000 0 0 440000 440000
17600 19360 21296 23425 25768 283449 311794 34297 37727 414998 456498
Operating Cost (Fixed) 00 00 00 60 16 7.6 7.4 42 16 7.9 6.7
22000 23760 25696 27825 30168 327449 355794 38697 42127 458998 500498
Operating Cost (Total) 00 00 00 60 16 7.6 7.4 42 16 7.9 6.7
40000 39000 38000 37000 36000 33000 32000
Salvage Value 0 0 0 0 0 350000 340000 0 0 310000 300000
 73920 51215 55391 59985 65039 705991 767156 83444 90846 989897
One Year carrying cost 00 60 36 30 23 4.8 6.3 43 67 3.9

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