Question

NEW PROJECT ANALYSIS You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $110,000, and it would cost another $27,500 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 $55,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $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 $50,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%. 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. $ 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 $ If the WACC is 10%, should the spectrometer be purchased?

Answer 1

Time line		0	1	2	3
Cost of new machine		-137500
Initial working capital		-11000
=1. Initial Investment outlay		-148500
3 years MACR rate			33.00%	45.00%	15.00%	7.00%
Savings			50000	50000	50000
-Depreciation	=Cost of machine*MACR%		-45375	-61875	-20625	9625	=Salvage Value
=Pretax cash flows			4625	-11875	29375
-taxes	=(Pretax cash flows)*(1-tax)		2775	-7125	17625
+Depreciation			45375	61875	20625
=after tax operating cash flow			48150	54750	38250
reversal of working capital					11000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				33000
+Tax shield on salvage book value	=Salvage value * tax rate				3850
=Terminal year after tax cash flows					47850
2. Total Cash flow for the period		-148500	48150	54750	86100
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-148500	43772.72727	45247.93388	64688.20436
3. NPV=	Sum of discounted CF=	5208.87

Accept project as NPV is positive