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.

WORKINGS