Question

This is problem 12-8 on page 429 of your text: You must evaluate the purchase of a spectrometer for the R&D department. The base price is $140,000, and it would cost another $30,000 to modify the equpment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $60,000. The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. The equipment would require an $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $50,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%. The firm's WACC ("hurdle rate" or "required rate of return") is 12%

Answer 1

Answers to first 4 parts of the question 7) Cash flow from sale of equipment in year-3 $40,7 (d) 8) Liquidation of net working capital in year-3 $8,000 >Option-(a) 9) Terminal cash flow in year-3 10) Net present value (NPV) 760 Option $48,760 Option-(c) I$40,760+ $8,000] ($19,549) -Option-(b)

Workings: Year-0 Year-1 Year-2 Year-3 $50,000$50,000$50,000 $56,100-$76,500-$25,500 [Ref: MACRS table] Savings in before-tax costs Less: Depreciation Expense Before-tax net cost savings Less: Taxes @ 40% After-tax net profit/ (loss) Add back dep. (Non-cash expense Annual Operating Cash Flows Cost of equipment After-tax salvage value Working capital invest & recovery Net annual cash flows (2) PV Factor @ 12% Present Value $6,100 -$26,500 $24,500-->(a) $2.440 $10,600 59,800|--> (a) x 40% $3,660-$15,900$14,700 $56,100 $76,500 $25,500 [Non-cash expense and so added back] $52,440$60,600$40,200 $170,000 [$140,000$30,000] $40,760 [Ref: Workings] $8,000 [Recovered at the end even if not given in the question] $8,000 $178,000$52,440$60,600$88,960 1.0000001 0.892857 0.797194 0.711780|[1/(1+12%)0; 1/(1+12%)1; 1/(1+12%); 1/(1+12%)3] $178,000 $46,821.43 $48,309.95 $63,319.97 2) x (3 Net Present Value (NPV)-$19,548.65 [Sum of present value from year-0 thru 3]

NOTE 3-year MACRS Table Initial investment $170,000 Less: Dep. till year-3 $158,100 [$56,100+ $76,500 +$25,500] Depreciation Capitalized Annual Year Book value at the end$11,900 Cost Dep S170,000 $56,100 $170,000 $76,500 $170,000 S25,500 $170,000 $11,900 $60,000 $48,100 [$60,000 $11,900] 33% 45% 15% 796 Sale value at the end Gain on disposal Tax Rate 1 2 40% 4 After-tax disposal value $40,760 [$60,000-($48,100 x 40%)]