Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $240,000, and it would cost another $36,000 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 $72,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $11,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $45,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

A. 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.

$  

B. 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 $  

C. If the WACC is 14%, should the spectrometer be purchased?

Answer 1

a. CFD = -$287,000: Initial investment outlay at t = 0: Price Modification CAPEX ANOWC Initial investment outlay ($240,000) (36.000) ($276,000) (11,000) ($287.000) Year 1 Savings Depreciation EBIT Taxes (40%) EBIT(1 -T) Add Depreciation EBIT(1 -T) + DEP $45,000 91.080 ($46,080) (18,432) ($ 27,648) 91.080 $63,432 Year 2 $45,000 124,200 (579,200) (31,680) (547,520) 124,200 $76,680 Year 3 $45,000 41,400 $3,600 1,440 $2,160 41,400 $43,560 Terminal cash flows at t = 3: Salvage value Tax on salvage value AT salvage value ANOWÇ = Recovery of NOWC Project FCFS = EBIT(1 -T) + DEP - CAPEX - ANOWC $72,000 21,072 $50,928 11,000 $63,432 $76,680 $105,488 Notes: 1. The depreciation expense in each year is the depreciable basis, $276,000, times the MACRS allowance percentages of 0.33, 0.45, and 0.15 for Years 1, 2, and 3, respectively. Depreciation expense in Years 1, 2, and 3 is $91,080, 5124,200, and $41,400. 2. Remaining BV in Year 4 = $276,000(0.07) = 519,320. Tax on SV = ($72,000 - $19,320)(0.40) = $21,072. C. The project has an NPV of ($101,153.73). Thus, it should not be accepted. | Year 0 1 2 3 Cashflow $ (287,000.00) $ 63,432.00 $ 76,680.00 $ 1,05,488.00 NPV PV @ 14% $ (287,000.00) $ 55,642.11 $ 59,002.77 $ 71,201.40 $ (101,153.73)

a. CFD = -$287,000: Initial investment outlay at t = 0: Price Modification CAPEX ANOWC Initial investment outlay ($240,000) (36.000) ($276,000) (11,000) ($287.000) Year 1 Savings Depreciation EBIT Taxes (40%) EBIT(1 -T) Add Depreciation EBIT(1 -T) + DEP $45,000 91.080 ($46,080) (18,432) ($ 27,648) 91.080 $63,432 Year 2 $45,000 124,200 (579,200) (31,680) (547,520) 124,200 $76,680 Year 3 $45,000 41,400 $3,600 1,440 $2,160 41,400 $43,560 Terminal cash flows at t = 3: Salvage value Tax on salvage value AT salvage value ANOWÇ = Recovery of NOWC Project FCFS = EBIT(1 -T) + DEP - CAPEX - ANOWC $72,000 21,072 $50,928 11,000 $63,432 $76,680 $105,488 Notes: 1. The depreciation expense in each year is the depreciable basis, $276,000, times the MACRS allowance percentages of 0.33, 0.45, and 0.15 for Years 1, 2, and 3, respectively. Depreciation expense in Years 1, 2, and 3 is $91,080, 5124,200, and $41,400. 2. Remaining BV in Year 4 = $276,000(0.07) = 519,320. Tax on SV = ($72,000 - $19,320)(0.40) = $21,072. C. The project has an NPV of ($101,153.73). Thus, it should not be accepted. | Year 0 1 2 3 Cashflow $ (287,000.00) $ 63,432.00 $ 76,680.00 $ 1,05,488.00 NPV PV @ 14% $ (287,000.00) $ 55,642.11 $ 59,002.77 $ 71,201.40 $ (101,153.73)