A company is contemplating investing in a machine to manufacture product X. The details are as follows:
- Investment required (Period 0): P1 million.
- Life span of the project: 3 years.
At the end of 3 years, the asset will be sold for P500,000 (disposal value).
Year 1 cash flow after tax will equal P300,000.
Year 2 cash flow after tax will equal P250,000.
Year 3 cash flow after tax will equal P200,000.
The company is currently financed equally (50:50) by debt and equity.
Ke (Cost of Equity): 20%
Kd (Cost of debt): 10% after tax.
REQUIRED:
a) Advise the company management on the correct decision to make using NPV calculation to prove your point.