Question

The president of your company, MorChuck Enterprises, has asked you to evaluate the proposed acquisition of a new chromatograph for the firm's R&D department. The equipment's basic price is $71,000, and it would cost another $15,500 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $32,400. The MACRS rates for the first three years are 0.3333, 0.4445 and 0.1481. (Ignore the half-year convention for the straight-line method.) Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,060. The machine would have no effect on revenues, but it is expected to save the firm $27,490 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 25%. Cash outflows and negative NPV value, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest dollar. a. What is the Year-O net cash flow? b. What are the net operating cash flows in Years 1, 2, and 3? (Note: Do not include recovery of NWC or salvage value in Year 3's calculation here.) Year 1: Year 2: Year 3: c. What is the additional (nonoperating) cash flow in Year 3? d. If the project's cost of capital is 14%, what is the NPV of the project? Should the chromatograph be purchased? -Select-

Answer 1

a.Initial Investment Outlay = Base Price + Modification cost + Increase in Working Capital
=-71000-15500-4060
-90560	since outflow
b.Annual Cash Flows:
	Year 1	2	3
Savings in Cost	27,490	27,490	27,490
Less: Depreciation	28,830	38,449	12,811
Net Savings	-1,340	-10,959	14,679
Less: Tax @40%	-335.11	-2,739.81	3,669.84
Income after Tax	-1,005.34	-8,219.44	11,009.51
Add: Depreciation	28,830	38,449	12,811
Cash Flow	27,825.11	30,229.81	23,820.16
Add: After tax salvage value			25,902.41
Recovery of Working capital			4,060
Additional cash flow			29,962
Cash Flow	27,825.11	30,229.81	53,782.58
Written down value	6,410
Sale price	32400
Gain on sale	25,990
Tax	6497.5875
After tax salvage value	25902.413
c.NPV = Present value of cash inflows – present value of cash outflows
= 27825.11*PVF(14%, 1 year) + 30229.81*PVF(14%, 2 years) + 53782.58*PVF(14%, 3 years) – 90560
-6589.441275
No, should not be purchased (since NPV is negative)