Question

NEW PROJECT ANALYSIS

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $190,000, and it would cost another $28,500 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $76,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $12,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $56,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

1. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent. Negative amount should be indicated by a minus sign.
   $

2. What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent.

   In Year 1 $

   In Year 2 $

   In Year 3 $

3. If the WACC is 13%, should the spectrometer be purchased?
   -Yes/No

Answer 1

1-
cost of equipment		-190000
Addition to equipment		-28500
investment in working capital		-12000
total cash outflow		-230500
2-
year	value to be depreciated of machine (cost of machine+addition)	MACRS rate	annual depreciation = (cost of machine+addition )*MACRS rate
1	218500	33%	72105
2	218500	45%	98325
3	218500	15%	32775
total depreciation accumulated			203205
book value of equipment at the end of year 3	218500-203205		15295
gain on sale of equipment	76000-15295		60705
tax on gain = 40%	60705*40%		24282
after tax net sale proceeds	76000-24282		51718
year		1	2	3
annual savings in labor cost		56000	56000	56000
less annual depreciation		72105	98325	32775
operating savings		-16105	-42325	23225
after tax savings = operating savings*(1-tax rate)		-9663	-25395	13935
add annual depreciation		72105	98325	32775
recovery of working capital				12000
after tax net sale proceeds				51718
net operating cash flow		62442	72930	110428
3-
year	0	1	2	3
total cash outflow	-230500
net operating cash flow		62442	72930	110428
present value factor at 13%	1	0.884955752	0.78314668	0.693050162
present value of cash flow = net operating cash flow*present value factor	-230500	55258.40708	57114.8876	76532.14332
NPV = sum of present value of cash flow	-41594.6
no equipment should not be purchased as it results in negative NPV