Megatrend Berhad is considering to start a new project. The company is planning to purchase a new

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Question:

Megatrend Berhad is considering to start a new project. The company is planning to purchase a new machine at a cost of RM280,000.00. In addition, the company need to pay RM40,000.00 for the shipping costs. In order to make the machine works effectively, it need to be installed by a special team. The installation cost for this machine is RM50,000.00 the machine has an estimated residual value of RM20,000.00 and a useful life of 10 years.

The firm’s old machine has a book value of RM135,000.00 but can only be sold for RM110,000.00. It was being depreciated at the rate of RM13,500.00 per year under an old depreciation method, and will be depreciated for another 10 years. If the company buys the new machine, the old machine will be sold to another company located at the same area.

Megatrend has employed a financial consultant to do the cost benefit analysis of buying this new machine. The consultation fees of RM8,000.00 has been paid recently.

The new machine is expected to save RM72,000.00 before taxes through reduced fuel but will increase the maintenance cost by RM10,000.00 before taxes. The cost of capital for Megatrend is 12 percent, and the corporate tax rate is 28 percent.

REQUIRED:

a. Calculate the initial outlay for the purchase of the new machine.

b. Calculate the annual after-tax cash flow and terminal cash flow.

c. Calculate the payback period, net present value, and profitability index. Should the company buy the machine?

d. Why the payback period method is not considered as the best technique for capital budgeting decision?