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Erinvale Limited is considering investing in a new automated packaging line that has a cost of R5,000,000. The asset has a useful life of five
Erinvale Limited is considering investing in a new automated packaging line that has a cost of R5,000,000. The asset has a useful life of five years and is expected to produce before-tax cash flows (EBITDA) of R1,500,000 a year in todays money. This will grow by inflation of 3% a year from the beginning of year 1. Erinvale will depreciate the asset over four years at 25% a year on a straight-line basis for tax purposes and expects to be able to sell the asset at the end of the fifth year for 10% of its cost in year five Rands. In addition, installation costs of R500 000 are anticipated and additional upfront net working capital requirements for the line of R500 000 are expected. Erinvales nominal cost of capital is 8%, the interest rate is 4%, the tax rate is 30% and tax is paid in the same year that cash flows are received. HINTS: Calculate NOPAT = EBIT Tax Assume that the cashflows are earned at the end of the year. Required: a) Advise the directors whether to accept or reject the project. b) What is the minimum EBITDA in Year 0 required to make the project viable
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