Problem
SIBA Pty Ltd is considering the purchase of a new plant worth of $325 000. They expect this plant will result in increase of EBIT $75 000 per year. This plant required proper training for effective operation. To operate this plant, workers would have to go through a brief training session that would cost $3500 after tax. In addition, it would cost $10000 after tax to come into fully operating condition. Also, because this plant is extremely efficient, its purchase would necessitate an increase in inventory of $25 000. The plant has an expected life of 10 years, after which it will have no salvage value. Note: Assume that firm uses simplified straight-line depreciation to a book value of zero, a 30% tax rate and a required rate of return of 10%.
Task
A. What is the initial outlay and incremental free cash flow associated with this project for year 1 to 9?
B. What is the terminal cash flow in year 10 (i.e. what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with termination of the project)?
C. Should this machine be purchased? Why or why not