Question

6. Problem 12.08 (New Project Analysis) eBook You must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $60,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $30,000. The equipment would require a $7,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $36,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 25%. a. What is the initial investment outlay for the spectrometer, that is, what is the Year O project cash flow? Enter your answer as a positive value. Round your answer to the nearest dollar. b. What are the project's annual cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar. Year 1: $ Year 2: $ Year 3: $ c. If the WACC is 13%, should the spectrometer be purchased? -Select-

Answer 1

a). Cash flow at year 0 = Cost of Machine + Investment in NWC

= $60,000 + $7,000 = $67,000

b). Cash Flow(Year 1) = Savings in costs * (1 - t)

= $36,000 * (1 - 0.25) = $27,000

Cash Flow(Year 2) = $27,000

Cash Flow(Year 3) = Annual cash flow + After-tax salvage value + Recovery of investment in NWC

= $27,000 + [$30,000 * (1 - 0.25)] + $7,000 = $27,000 + $22,500 + $7,000 = $56,500

c). NPV = PV of Cash Inflows - PV of Cash Outflows

= [$27,000 / (1 + 0.13)] + [$27,000 / (1 + 0.13)²] + [$56,500 / (1 + 0.13)³] - $67,000

= $23,893.81 + $21,144.96 + $39,157.33 - $67,000

= $17,196.10

Yes the spectrometer should be purchased as its NPV is positive.