Low Aspirations, a company in Nowhere Ville is considering an investment in some new plant & machinery for its factory. These fixed assets will generate additional sales revenues for the firm, but will not replace any existing fixed assets. The plant & machinery will have a 3-year life for depreciation purposes under Australian tax regulations and would be fully depreciated by the prime cost method over those years (this is a straight-line depreciation method). It is planned to sell the plant & machinery at the end of the third year of usage.Low Aspirationswill need to factor in additionalNet Operating Working Capital.Important additional information is set out below.

Required return for projects of this risk level New investment in fixed capital Incremental Sales Revenue in year 1 Incremental cash operating costs as a percentage of incremental sales revenues Expected pre-tax proceeds from selling equipment

Company tax rate

12.5% $1 M $800,000

40% $200,000 30%

It is expected that in year 2 Sales dollars will exceed sales in Year 1 by 12%. It is expected that in year 3 Sales dollars will exceed sales in Year 2 by 8%.

Information to do with Net Operating Working Capital (NOWC)

Additions to inventories at outset of project Additions to trade accounts receivable at outset of project Additions to trade accounts payable at outset of project

$100,000 $70,000 $80,000

At the end of year 1 a further 12% ofNOWCwill be required. At the end of year 2 a further 8% ofNOWCwill be required. The company will recover all theNet Operating Working Capitalat the end of Year 3.

Required:

1. Determine the incremental undiscounted cash flows associated with this investment in plant & machinery. Show all workings.
2. Calculate the Net Present Value (NPV) of the investment. Show all workings.
3. What is the Profitability Index (PI) of the investment? Show all workings.
4. Calculate the Internal Rate of Return.
5. Advise if you would recommend thatLow Aspirationsinvests in the new plant & machinery or not and give robust reasons as if you were explaining the recommendation to a senior manager who had never studied Capital Budgeting. Make sure that you explain what NPV, IRR and PI mean conceptually.