Repairing or replacement of Machine.

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From:Subject: Repairing or replacement of Machine.

Zenix Corporation has two options when it comes to the machine we are using. The first option is to replace the machine or to repair it but all these will depend on the available funds. Repairing the machine will require an outflow of $ 1,500,000. To replace the machine we will need an outflow of $ 9,000,000. It is evident that the cost of repairing is lower than the cost of replacing. This will cut down the number of returns from the customers and will increase the cash flow. On the other hand the cost of replacement is much higher than the cost of repairing but this will result in generation of new sales. Both of the options are capital budgeting decision and require huge amount of investment. So it is necessary to analyze profitability of each option before making any decision. For analyzing feasibility of both options we have used net present value method, internal rate of return, profitability index and payback period method of capital budgeting. Another important point to mention is that since the cost of capital is not certain and likely to vary between 10% to 14%, so, we have performed analysis by considering various WACC or required rate of return with five points at 9%, 11%, 13%, 15% and 17%. Thus there are five different analysis is performed for all the capital budgeting methods used in the analysis.

The result of all the analysis and all the methods are all at discount rate and are in favor of replacement of machinery. The option of replacement has higher net present value, higher internal rate of return and profitability index and lower payback period. Thus if the company has funds available then it is advisable to select the option of replacement of machinery as opposed to repairing the machine. It is important to mention that discounted payback period of the replacement option is more than three years with the cost of capital of 13% and above. So according to the discounted payback criteria this decision should be taken if the company can arrange funds at a cost of 11% or lower.