Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $60,000, and it would cost another $12,000 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 $30,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $42,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 35%.

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 cent.
   $  
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 cent.
   Year 1: $   
   Year 2: $   
   Year 3: $  

Answer 1

Initial Investment Outlay:

Cost = $60,000

Modification Cost = $12,000

Increase in Net working Capital = $8,000

Initial Outlay = $80,000

Calculation of annual cash flows:

	Year 1	Year 2	Year 3
Savings in cost	42,000	42,000	42,000
Less: Depreciation	23,760	32,400	10,800
Net Income	18,240	9,600	31,200
Tax @35%	6,384	3,360	10,920
After Tax	11,856	6,240	20,280
Cash Flow = After tax income+ depreciation	$35,616	$38,640	$31,080

Additional Cash flow in year 3 = Salvage Value net of tax + Working capital Release

= 30,000 - (30,000-5,040)(35%) +8,000

= $29,264

Hence, annual cash flow in year 3 = 29,264+31,080 = $60,344