(a)Describe in brief the greatest difficulties faced in capital budgeting in the real world.
(5 marks)
(b)Mumias Milling Company purchased a grinder 3 years ago at a cost of Sh.3.5 million. The grinder had a life of 8 years at the time of purchase. It is being depreciated at 15% per year on a declining balance. The company is considering replacing it with a new grinder costing Sh.7 million with an expected useful life of 5 years.
Due to increased efficiency, the profit before depreciation is expected to increase by Sh.400,000 a year. The old and new grinders will now be depreciated at 25% per year on a declining balance for tax purposes.
The salvage value of the new grinder is estimated at Sh.210,000. The market value of the old grinder, today, is Sh.4 million. It is estimated to have a zero salvage value after 5 years.
The company’s tax is 30% and the after tax cost of capital is 12%.
Required
Should the new grinder be bought? Explain. (15 marks)
(Total: 20 marks)
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