Question

The base price of a spectrometer is $140,000, and shipping and installation costs would add another $30,000. The machine falls into the MACRS 3-year class (33%, 45%, 15% and 7%) and it would be sold after 3 years for $60,000.

The machine would require a $8,000 increase in working capital (increased inventory less increased accounts payable).

There would be no effect on revenues, but pre-tax labor costs would decline by $50,000 per year.

The marginal tax rate is 40%, and the WACC is 12%.

1. What is the initial investment outlay, that is, the Year 0 project cash flow?
2. What are the total cash flows during Years 1, 2, and 3?
3. Should the machine be purchased? Explain your answer.

Answer 1

Time line		0	1	2	3
Cost of new machine		-170000
Initial working capital		-8000
=Initial Investment outlay		-178000
3 years MACR rate			33.00%	45.00%	15.00%	7.00%
Savings			50000	50000	50000
-Depreciation	=Cost of machine*MACR%		-56100	-76500	-25500	11900	=Salvage Value
=Pretax cash flows			-6100	-26500	24500
-taxes	=(Pretax cash flows)*(1-tax)		-3660	-15900	14700
+Depreciation			56100	76500	25500
=after tax operating cash flow			52440	60600	40200
reversal of working capital					8000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				36000
+Tax shield on salvage book value	=Salvage value * tax rate				4760
=Terminal year after tax cash flows					48760
Total Cash flow for the period		-178000	52440	60600	88960
Discount factor=	(1+discount rate)^corresponding period	1	1.12	1.2544	1.404928
Discounted CF=	Cashflow/discount factor	-178000	46821.42857	48309.949	63319.971
NPV=	Sum of discounted CF=	-19548.6516

Reject as NPV is negative