Question

The base price of a spectrometer is $140,000, and shipping and installation costs would add another $30,000. The machine falls into the MACRS 3-year class (33%, 45%, 15% and 7%) and it would be sold after 3 years for $60,000.

The machine would require a $8,000 increase in working capital (increased inventory less increased accounts payable).

There would be no effect on revenues, but pre-tax labor costs would decline by $50,000 per year.

The marginal tax rate is 40%, and the WACC is 12%.

1. What is the initial investment outlay, that is, the Year 0 project cash flow?

2. What are the net operating cash flows during Years 1, 2, and 3?

3. Should the machine be purchased? Explain your answer.

Answer #1

1.Initial outlay = -Cost of sequipment- Shiiping - Working capital

= -178000

2.

OCF | MACRS 3 year | |||||

Year | Cash flows | Depreciation | EBIT | Tax | PAT | OCF |

1 | 50000 | -56100 | -6100 | 2440 | -3660 | 52440 |

2 | 50000 | -76500 | -26500 | 10600 | -15900 | 60600 |

3 | 50000 | -25500 | 24500 | -9800 | 14700 | 40200 |

Salvage | |

Purchase price | 170000 |

Less: Depreciation | -158100 |

Closing book value | 11900 |

Selling price | 60000 |

Gain/(loss) | 48100 |

Tax | 16835 |

Net salvage | 43165 |

Year | Initial cash flow | OCF | Working capital | Salvage post tax | Net cash flow |

0 | -170000 | -8000 | -178000 | ||

1 | $52,440.00 | 52440 | |||

2 | $60,600.00 | 60600 | |||

3 | $40,200.00 | 8000 | 43165 | 91365 |

3. NPV is - $17,836.82

Since NPV is lesser than zero, the machine should not be purchased since it is reducing the value of the firm.

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