Should Perfidia Pte Ltd Invest in a New Medical Glove Machine?

Perfidia Pte Ltd (�PPL�) is considering replacing one of its outdated machines that produces medical gloves. This machinery was purchased for $70,000 seven years ago. The net book value is currently $25,000. The replacement machine costs $139,350 and will be sold for $20,000 in five years� time.�

The new machine is expected to increase unit sales by 6,000 gloves per annum. The estimated unit selling price is $35 for the first year.�

The following table provides the unit costs for the first year:�
� � $
Direct labour, 5 hours at $2 per hour � �10
Direct materials � �7
Fixed costs including depreciation � � 11
Total � �28

PPL envisage there will be short of supervisory staff due to the COVID-19 pandemic in Singapore. It has decided to divert some staff from another division to the new project. These staff earn a contribution of $2 per direct labour hour in their own division. The fixed overhead cost would be $2.20 per hour and this is expected to remain unchanged.

The sales agreement for the gloves specifies the sale price to rise at the rate of 10 percent per year after the first year. The unit costs, except for fixed costs, is expected to increase at the same rate as the selling price.

Working capital requirements are expected to be $15,000 in the first and second years, increasing to $18,000 in the third year and is expected to remain at this level till the end of the project. All the amounts of working capital will be recovered at the time of project termination.�
Due to the nature of PPL�s products, the company falls under the �tax-free� category. The risk-adjusted return for PPL�s projects is 27 percent per annum.
Required:�
Identify the relevant cash flows for the decision as to whether or not PPL should proceed to purchase the new machine.�

In order to decide whether or not PPL should proceed to purchase a new machine, the relevant cash flows that need to be considered include:

1. Initial investment: The cash outflow required to purchase the new machine including any installation or set-up costs.

2. Operating costs: The ongoing expenses associated with the new machine, such as maintenance, repair, and energy costs.

3. Increased revenue: The additional revenue that can be generated from using the new machine, such as increased production, sales or efficiency gains.

4. Salvage value: The expected cash inflow from selling the machine at the end of its useful life.

5. Opportunity cost: The cash flows that will be foregone by investing in the new machine instead of an alternative investment opportunity with similar risk.