Initial Investment = Base Price + Modification Cost
Initial Investment = $240,000 + $60,000
Initial Investment = $300,000
Useful Life = 3 years
Depreciation Year 1 = 33% * $300,000
Depreciation Year 1 = $99,000
Depreciation Year 2 = 45% * $300,000
Depreciation Year 2 = $135,000
Depreciation Year 3 = 15% * $300,000
Depreciation Year 3 = $45,000
Book Value at the end of Year 3 = $300,000 - $99,000 - $135,000
- $45,000
Book Value at the end of Year 3 = $21,000
After-tax Salvage Value = Salvage Value - (Salvage Value - Book
Value) * tax rate
After-tax Salvage Value = $120,000 - ($120,000 - $21,000) *
0.40
After-tax Salvage Value = $80,400
Initial Investment in NWC = $9,000
Answer a.
Year 0:
Net Cash Flows = Initial Investment + Initial Investment in
NWC
Net Cash Flows = -$300,000 - $9,000
Net Cash Flows = -$309,000
Answer b.
Year 1:
Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax *
Depreciation
Operating Cash Flow = $36,000 * (1 - 0.40) + 0.40 * $99,000
Operating Cash Flow = $61,200
Net Cash Flows = Operating Cash Flow
Net Cash Flows = $61,200
Year 2:
Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax *
Depreciation
Operating Cash Flow = $36,000 * (1 - 0.40) + 0.40 * $135,000
Operating Cash Flow = $75,600
Net Cash Flows = Operating Cash Flow
Net Cash Flows = $75,600
Year 3:
Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax *
Depreciation
Operating Cash Flow = $36,000 * (1 - 0.40) + 0.40 * $45,000
Operating Cash Flow = $39,600
Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax
Salvage Value
Net Cash Flows = $39,600 + $9,000 + $80,400
Net Cash Flows = $129,000
Answer c.
Required Return = 13%
NPV = -$309,000 + $61,200/1.13 + $75,600/1.13^2 +
$129,000/1.13^3
NPV = -$106,231.35
NPV of the spectrometer is negative. So, you should not purchase the spectrometer.
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