Case Study - 14

Restore Incorporated
(The Replacement Decision in Capital Budgeting)

Submitted by
Zaighum Hussain

MBAR 143003

Muhammad Mehdi

MBAR 143011

Muhammad Hamza Tariq

MBAR 143028

Muhammad Talha Tahir

MBAR 143061

Submitted to:

Sir, Nasir Rasool

Capital University of Science and Technology CUST Islamabad

CERTIFICATION
It is certified that the contents and form of report entitled Case study 14. Restore
Incorporation (The Replacement Decision in Capital Budgeting) submitted by Zaighum
Hussain (MBAR-143003), Muhammad Mehdi (MBAR-143011) , Hamza Tariq (MBAR143028) and Muhammad Talha Tahir (MBAR-143061) have been found satisfactory for
the requirement of course Financial Management of the degree of Masters in Business
Administration.

Course and Project Supervisor :

________________________

Prof. Nasir Rasool

Lecturer, Department of Management Sciences,
Capital University of Science and Technology CUST, Islamabad

ACKNOWLEDGEMENT
First of all, we are very thankful to Almighty Allah, who blessed us with skills, talent, energy
and confidence that made us successfully complete our final project of management. Though
its a useful task, it needs committed efforts, study, devotion and most of all guidance to be
accomplished successfully. Among all these elements, guidance and study is of maximum
importance.
We are very thankful to Sir, Nasir Rasool for his massive guidance at every stage. He did
his best to make us understand everything. This project would not have been possible without
his cooperation and continuous direction.

II

TABLE OF CONTENTS

1. Certification
2. Acknowledgement
3. Introduction of Case Study... 01
4. Question Answers......01
4.1. Compound Growth Rate.... 01
4.2. Tax Saving on Depreciation...... 02
4.3. Cash Flow...... 03
4.4. NPV and IRR......... 03
4.5. Remaining Question Answers........... 04

III

Case Study - 14

Restore Incorporated
(The Replacement Decision in Capital Budgeting)
Introduction of the Case Study
Restore Incorporated was organized in 1975 by Ted Schadler and his son, Bob. The company
restore classic and antique cars in terms of both body and engine work. . The company began
as an extension of Ted Schadlers hobby, fixing up old cars for himself and his friend, as the
hobby grew a shop was acquired and soon there was more work than could be handled by one
person so that business hire and train additional help. The company was located in large south
eastern U.S city and drew customers from at least a 300 miles radius .Restore had 10
employees.
Question: 01 Comment upon the company's "process" for assessing capital budgeting ideas?
Answer: In Internal investment (capital Budgeting) are handled efficiently the usual sources
of ideas for such expenditure are the sale and marketing staff the companys cost accountants
research and development personals and the engineering or production staff in a company
such as restore where in the management structure is very economical, usually the cost
accountant, top management and the representative from the manufacturer major expenditure
decision.
Question: 02 Calculate compound growth rates for the companys projected revenue and
earnings?
Sr.No
Year
1
1996
2
1997
3
1998
4
1999
Compound Growth
Rate

Revenue
6000
6900
7866
8445

Earning After Tax

440
464
538
652

8.92%

10.33%

Question: 03 Evaluate the cash flows for the purchase of the Automaster 1 and the
replacement of the original machine?
a). Salvage Value
Sr. No
1
2
3

Probability
0.3
0.2
0.5
Salvage value

Estimate

Value

5000
7000
6500

1500
1400
3250
6150
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b). New Machine Annual Depreciation

Cost of Automaster 1

60000

(-)Salvage value

(6150)

Remaining
53850
Annual Depreciation
6731.25
*Annual Depreciation: 53850/8 = $6731.25

Sale of Old Machine

Cost
15000
Tax
30%
Sale
10500
Tax: 15000 x 30% = 4500

c). Old Machine Annul Depreciation

Old Machine
24000
Annaul Dep.
2400
*Annual Depreciation: 24000/10 = $2400

New Machine Annul Depreciation

0
60000
1
6731.25
53268.75
2
6731.25
46537.50
3
6731.25
39806.25
4
6731.25
33075.00
5
6731.25
26343.75
6
6731.25
19612.50
7
6731.25
12881.25
8
6731.25
6150.00
Remaining Value
6150.00
Net Salvage
4305.00
*Net Salvage = 6150(6150 x 30% tax)

Preparing: Tax Saving from Depreciation

Tax Saving from Depreciation
Year
New
Machine
Old
Machine
Inc. &
Dec. in
Dep.
Tax Rate
Tax
savings

6731.25

6731.25

6731.25

6731.25

6731.25

6731.25

6731.25

6731.25

2400

2400

2400

2400

2400

2400

2400

2400

4331.25

4331.25

4331.25

4331.25

4331.25

4331.25

4331.25

4331.25

30%

30%

30%

30%

30%

30%

30%

30%

1299.375 1299.375 1299.375 1299.375 1299.375

1299.375

1299.375 1299.375

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Preparing: Cashflow

Year
Purchase
of
Automaster
I
Sale of Old
Machine

Cashflows
4

1299.375

1299.375

1299.375

1299.375

1299.375

1299.375

1299.375

60000
10500

Tax
Savings

1299.375

Net
Salvage
Net
Working
Capital

4305

-2000

Net
Operating
Income
Net
Cashflow

51500

2000

8400

8400

8400

8400

8400

8400

8400

8400

9699.375

9699.375

9699.375

9699.375

9699.375

9699.375

9699.375

16004.375

Calculating: NPV and IRR

NPV (Internal Rate of Return)
IRR (Net Present Value)

Sr.No
1
2
3
4
5
6
7
8

Inflows
9699.3750
9699.3750
9699.3750
9699.3750
9699.3750
9699.3750
9699.3750
16004.3750

Outflows

NPV

IRR

8%
8980.9028
8315.6507
7699.6766
7129.3302
6601.2316
6112.2525
5659.4922
8646.6658

11.5920%
8691.8193
7788.9269
6979.8255
6154.7723
560.0365
5022.7942
4501.0343
6655.4010

-51500

-51500

7645.2000

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Question: 04 Is there an economic justification for the replacement? Please explain your
answer?
Answer: Yes, the NPV at 8% cost of capital is 7645.20 and IRR is 11.5920%. Thus,
replacement will result in economic benefits.
If machine is replaced would provide labor saving and cost of classes to strength the skill and
commitment and to monitor progress of labor will also be decreased as two labor were shifted
to the programming department.
Question: 05 Should the original machine be replaced?
Answer: Yes, the machinery should be replaced as it is increasing the profits.
Question: 06 Comment upon the ethical and other aspects of the company's potential
reduction of its workforce?
Answer: According to ethical responsibility and commitment, they should not reduce the
workforce. But, if the company does not adopt technology for production the company will
be thrown out from the market.
Question: 07 What additional economics information would be useful in the replacement
decision?
Answer: Following are the additional information would be useful for the replacement
decision

Any increase or decrease in maintenance and repair cost

Discount rate for the investment by the company
Estimate Salvage value not based on probability

Question: 08 Assess the Schalder's concern over the ethics question?

Answer: Schalder's concern over the ethical question is logical and justified as the major
chunk of their company's labor comes from the training programs which are also helpful in
improving the social life of the people. Since he is a major spokesperson for the program and
most of the colleagues are recruited there, it will be quite unethical and immoral to reduce the
workforce for the short term economic gains. But if he still reduces the workforce, then he
might be questionable about the role in the employment of the young people who are
benefited through the training programs and most of their mentors are working voluntarily.
Question: 09 Discuss the probability estimate of the new machine's salvage value. It is
reasonable that the manufacturer would be involved in the process?
Answer: Although the probability estimates of new machine seems reasonable (the salvage
value is equal to the estimates) but this should have been made through an independent
assessment rather than manufacturers involvement.

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Question: 10 Consider the company's size (sales and assets) and its line of business-will
unforeseen obsolescence of the Automaster I affects the potential replacement of this
machine?
Answer: Yes, given the balance sheet composition of the company and project revenues, an
unforeseen obsolescence will significantly impact the existence of the company.
Considering the business nature and size of the Restore incorporated, the investing of
$60,000 is not a small amount. The machines and technology change rapidly which make
difficult for the small business to upgrade their technology and machinery accordingly.

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