Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $270,000, and it would cost another $40,500 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 $108,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $10,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $37,000 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 14%, should the spectrometer be purchased?

Answer 1

Year	Net Cash flows
0	-320500
1	63186
2	78090
3	193627.6

No the machine should not be purchased since the NPV is negative.

Workings

Year	Cost of new machine	Working capital	Tax shield- depreciation	Sale of new machine	(Sales-cost) after tax	Net CF
0	-310500	-10000				-320500
1			40986		22200	63186
2			55890		22200	78090
3		10000	18630	142797.6	22200	193627.6
					NPV	-74292.85

After tax CF from sale of machine
Purchase price	310500
Less : depreciation	115506
Book value	194994
Selling price	108000
Gain	-86994
Tax	-34797.6
Net CF	142797.6

AutoSaver HD Book1 - Excel Sign in - 0 X File Home Insert Draw Page Layout Formulas Data Review View Help Tell me what you want to do Comments Share AY - 10 A = = D. Calibri BIU - B O -A A = E Insert - Delete - Format Paste LA- - General 3$ -% to Number . Conditional Format as Formatting Table - Cell Styles Sort & Find & Filter - Select Editing Clipboard Font Alignment Styles Cells B1 - X fi Cost of new A AB Year Cost of new machine Net CF Working capital Tax shield- depreciation Sale of new machine (Sales-cost) after tax After tax CF from sale of machine 20 -270000-40500 -10000 --$B$2*33%*40% --$B$2*45% 40% --$B$2*15%*40% =37000*(1-40%) =37000*(1-40%) =37000*(1-40%) =SUM(B2:F2) =SUM(B3:F3) =SUM(B4:F4) =SUM(B5:F5) 10000 =18 Purchase price =270000+40500 Less : depreciation =SUM(D3:05) Book value =J2-13 Selling price 108000 Gain =45-14 Tax =J6*40% Net CF =J5-7 NPV =NPV(14%,G3:55)+G2 Sheet1 Ready E + 100% -- -_ ENG 5:59 AM ^ D