Question

1) Emeco Holdings Limited (Emeco) is a company listed on the Australian Securities Exchange (ASX). Emeco is investigating a proposal to replace one of their outdated carth-moving excavators with a new CAT 390F excavator. The new excavator has a much larger carrying capacity, offers improved fuel economy and has lower maintenance costs compared to the existing excavator. However, the cost of a brand new CAT 390F is $2.8 million and Emeco's accountant is concemed that the net profit of the new excavator won't generate a fast enough payback period. Therefore, the accountant has approached the Chief Financial Officer (CFO) to express concerns. The CFO carefully explains the many reasons that profitability is not a good measure of financial success, and stresses that the appropriate action is to conduct a rigorous cost-benefit analysis to determine if the new excavator can“... deliver on the outcomes desired by its shareholders ..." (pg. 21, 2019 Annual Report) - namely, wealth creation. 2) Last month, Emeco paid for a study by an earthworks consultant at a cost of $487,000 and the study concluded that the large and growing infrastructure market will generate sufficient demand for a larger excavator. Today, Emeco must decide if they will proceed with the investment in the new excavator, and the simultaneous sale of their existing excavator. 3) According to the Australian Taxation Office (ATO) the new excavator has a sixteen-year life for taxation purposes. 4) Road and Maritime Services (RMS) requires that all heavy vehicles (including excavators) have a Certificate of Roadworthiness that indicates that the excavator has been inspected and found to comply with the minimum standards set out in NSW vehicle licencing legislation. The compulsory certificate is required before Emeco commences operations with the new excavator. Certification requires Emeco to spend $200,000 on safety equipment. The certificate expires four years later at which time the excavator must be recertified and the safety equipment replaced at an estimated cost of $200,000. Recertification must occur every four years. The safety equipment has no value in the secondary market. Present an itemised breakdown (and the total) for each of the following: 1. The cash flows at the start. 2. The cash flows over the life. 3. The cash flows at the end. 4. The NPV of the new excavator and an explanation of your recommendation.

Answer 1

1. Cash flow at the start: $ 2.8 Million as this is the cost to buy the brand new CAT390F for the replacement of an old earth moving excavators. There is no other cash flow associated at the start.

2. The cash flow over the life: As the road and maritime services required certification and the cost of the same is $ 2,00,000 which has the validity of only four years and after every four years they need to renew the certificate with the same amount. so the cash flow which is required over the life is $ 8,00,000 for all sixteen years of life for the new CAT390F excavators.

3. The cash flow at the end: Emeco need to invest a total of $ 2.8 million and $ 8,00,000 for the new excavator during the life time. That makes a total of $ 28,80,000.

4. NPV and recommendation: with the limited information given on the above question it is difficult to predict the NPV because we need the cash inflow also from the new investment which is not available here in this question but if the cash inflow will generate more than $ 28,80,000 for all the sixteen years and it is discounted with the current inflation rate just to find out the present value and if it gives the positive amount than yes the project should be accepted because of the positive cash flow. They should process with investment in the new excavator. But if it generate the negative cash flow than it is very risky to buy new excavator.