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