XYZ Ltd., a firm in the 40 percent marginal tax bracket with a 12 percent required rate of return or cost of capital, is expanding rapidly and hence it is considering buying a new machine to support its expected higher production capacity. The new machine model would cost the firm K19,900,000. This price is inclusive of freight charges, but the company has to pay for the installation cost of K100,000 separately.

The new machine would facilitate the firm to achieve the following sales over the expected life of 4 years.

Year Units Sold

1 80,000

2 90,000

3 100,000

4 70,000

Sales price per unit: K400/unit

Variable cost per unit: K150/unit

Annual fixed costs: K500,000

Working-capital requirements: There will be an initial working-capital requirement of K200,000 to get production started. A ll working capital is liquidated at the termination of the project at the end of year 4.

The depreciation method: Use the simplified straight-line method over 4 years. It is assumed that the plant and equipment will have no salvage value after four years.

1. Determine the free cash flows associated with the project for year 0 to 4.

2. Determine the projects net present value. Should the firm invest in this project based on NPV criteria? Explain.

c. What is the payback period of the project? What are the advantages and disadvantages of the payback period?