Question

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You must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $70,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $22,000. The equipment would require an $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 $28,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 25%.

1. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Enter your answer as a positive value. Round your answer to the nearest dollar.
   $  
2. 
   
3. What are the project's annual cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar.
   Year 1: $  
   Year 2: $  
   Year 3: $  
4. 
   
5. If the WACC is 11%, should the spectrometer be purchased?
   -Select-YesNoItem 5

Answer 1

a:

Cashflow( outflow)= invstment in machine + increase in working capital

=70000+11000 =81000

c:

Cash inflow Year1= Saving in cost*(1-tax rate)

=28000*(1-.25)=21000

Cash inflow Year2= Saving in cost*(1-tax rate)

=28000*(1-.25)=21000

Cash inflow Year3= Saving in cost*(1-tax rate) +aftr tax salvage value + decrease in working capital

=28000*(1-.25) + 22000*(1-.25)+11000 =48500

e:

We need to calculate npv at 11%

NPV= PV of cash inflow- PV of cash outflow

[21000 / (1 + 0.11)] + [21000 / (1 + 0.11)²] + [48500 / (1 + 0.11)³] - 81000

=-11424.07

since npv is negative, the machine should not be purchased.