Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $60,000, and it would cost another $9,000 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 $27,000. 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 $69,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 35%.

What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Enter your answer as a positive value. (Round your answer to the nearest cent.)

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 cent.

If the WACC is 10%, should the spectrometer be purchased?

Answer 1

Time line		0	1	2	3
Cost of new machine		-69000
Initial working capital		-11000
= . Initial Investment outlay		-80000
3 years MACR rate			33.00%	45.00%	15.00%	7.00%
Savings			69000	69000	69000
-Depreciation	=Cost of machine*MACR%		-22770	-31050	-10350	4830	=Salvage Value
=Pretax cash flows			46230	37950	58650
-taxes	=(Pretax cash flows)*(1-tax)		30049.5	24667.5	38122.5
+Depreciation			22770	31050	10350
=after tax operating cash flow			52819.5	55717.5	48472.5
reversal of working capital					11000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				17550
+Tax shield on salvage book value	=Salvage value * tax rate				1690.5
=Terminal year after tax cash flows					30240.5
. Total Cash flow for the period		-80000	52819.5	55717.5	78713
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-80000	48017.72727	46047.52066	59138.24192
. NPV=	Sum of discounted CF=	73203.49

Purchase as NPV is positive