Arkwright Mills Corporation is considering expanding its production of a new yarn, code name XI5. The plant is expected to cost $1 million and have a life of five years and no residual value. It will be bought, paid for, and ready for operation on December 31, Year 0. $500,000 has already been spent on development costs of the product, and this has been reflected in the income statement in the year it was incurred.
The following results are projected for the new yarn:

Tax is charged at 50% on annual profits (before tax and after capital cost allowance, which exactly matches depreciation in this case) and paid one year in arrears. Depreciation of the plant has been calculated on a straight-line basis. Additional working capital of $0.6 million will be required at the beginning of the project and released at the end of Year 5. You should assume that all cash flows occur at the end of the year in which they arise.

Required:
(a) Prepare a statement showing the incremental cash flows of the project relevant to a decision concerning whether or not to proceed with the construction of the new plant.
(b) Calculate the net present value of the project using a 10% discount rate.
(c) Calculate the payback period to the nearest year. Explain the meaning of this term.

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Year 1 1.2 1.0 (S millions) Year 2Year 3Year 4 14 Year 5 1.4 1.1 Sales 1.4 1.4 Costs, including depreciation- Profit before tax 22 03 03