Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $90,000, and it would cost another $13,500 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 $40,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $9,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $37,000 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.

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

Cash flows:

Year 0 = -112500

Year 1= $35862

Year 2= $ 40830

Year 3= $64608

NPV = $2386.57

Yes the spectrometer should be purchased since NPV is positive.

Working:

INPUTS | Salvage | ||||||||||

Initial cost | 103500 | Year | Initial cash flow | OCF | Working capital | Salvage | Net cash flows | Purchase price | 103500 | ||

Tax rate | 40% | 0 | -103500 | -9000 | -112500 | Less: Depreciation | -96255 | ||||

Selling price | 40500 | 1 | $35,862.00 | 35862 | Closing book value | 7245 | |||||

Working capital | 9000 | 2 | $40,830.00 | 40830.00 | |||||||

MARR | 10% | 3 | $28,410.00 | 9000 | 27198 | 64608 | Selling price | 40500 | |||

Annual cash flow | 37000 | Gain/(loss) | 33255 | ||||||||

NPV | $2,386.57 | Tax/ Saving | -13302 | ||||||||

Net salvage | 27198 | ||||||||||

Year | Depreciation rate | OCF | MACRS 3 year | ||||||||

1 | 33.00% | Year | Cash flows | Depreciation | EBIT | Tax | PAT | OCF | |||

2 | 45.00% | 1 | 37000 | -34155 | 2845 | -1138 | 1707 | 35862.00 | |||

3 | 15.00% | 2 | 37000 | -46575 | -9575 | 3830 | -5745 | 40830.00 | |||

3 | 37000 | -15525 | 21475 | -8590 | 12885 | 28410.00 | |||||

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