Rubis Bhd. is considering an investment in new machinery in their production. The machinery costs RM2 million. It is expected to generate annual before-tax cash inflows of RM700,000 into perpetuity. The cost of production is expected to be 70% of the cash inflows. No inflation will be considered in this case. To invest in this machinery, Rubis needs to get 40% of non-traded irredeemable debenture with a coupon rate of 10%. The other 60% of fund will come from retained earnings in the company. The unlevered required rate of return is 20% and Rubis pays corporate tax at an annual rate of 30%.
Analyse and advise Rubis whether they should purchase the new machinery by using flow to equity method. State clearly the assumptions you make.