Question

13-7 New-Project Analysis The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm's RAD depart- ment. The equipment's basic price is $70,000, and it would cost another $15,000 to modify it for special use by your firm. The chromatograph, mwhich falls into the MACRS 3-year class, would be sold after 3 years for $30,000. The MACRS rates for the first 3 years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,000. The machine would have no effect on revenues, but it is expected to save the firm $25,000 per year in before- tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40%. a. What is the Year-O cash flow? b. What are the cash flows in Years 1, 2, and 3? Do not include recovery of blo NWC or salvage value in Year 3's calculation here. c. What is the additional cash flow in Year 3 from NWC and salvage? d. If the project's cost of capital is 10%, should the chromatograph be purchased? on.

Answer 1

	0	1	2	3
MACRS		0.3333	0.4445	0.1481	0.0741
Investment	-85,000				6298.5
NWC	-4,000			4,000
Salvage				30,000
Savings		25,000	25,000	25,000
Depreciation		-28,331	-37,783	-12,589
EBT		-3,331	-12,783	12,412
Tax (40%)		1,332	5,113	-4,965
Net Income		-1,998	-7,670	7,447
Cash Flow		26,332	30,113	20,035
Add. CF	-89,000			24,519
Total CF	-89,000	26,332	30,113	44,555
IRR	6.03%

Depreciation = MACRS % x Investment

Book Value of asset after 3 years = Investment - Total Depreciation = 6,298.5

Cash Flows (CF) = Net Income + Depreciation

Additional CF = Investment + NWC + (Salvage - Book Value) x (- Tax rate) + Salvage

Total CF = CF + Additional CF

IRR can be calculated using the same function on a calculator or excel

As IRR (6%) < cost of capital (10%), chromatograph should not be purchased.