08 May SHOULD THE COMPANY UNDERTAKE THE INVESTMENT?
The Hybee Company is evaluating an investment to produce a new product with an expected marketable life of 5 years. The expected annual net cash flow before tax is $120 000. To produce this product the company will have to acquire a new plant. The company can either purchase this plant or leave it. Details of these alternatives are as follows:PurchaseThe purchase price of the plant is $250 000 and it is expected that it will have a zero residual value after 5 years. The allowable annual depreciation charge on the plant is 20% per annum straight-line.LeaseThe lease requires five annual payments each of $60 000 payable at the beginning of each year. The company tax rate is 30 cents in the dollar. The required rate of return on the investment is 15% per annum after tax and the after-tax cost of an equivalent loan is 8% per annum. Should the company undertake the investment? If so should it purchase or lease the plant?
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