Question

New-Project Analysis The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department The equipment's basic price is $60,000, and it would cost another $9,000 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $15,000. Use of the equipment would require an increase in net working capital (spare parts inventory) of $3,600. The machine would have no effect on revenues, but it is expected to save the firm $24,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 35%. What is the Year-0 net cash flow? If the answer is negative, use minus sign. $

What are the net operating cash flows in Years 1, 2, and 3? Round your answers to the nearest dollar. Year 1 $ Year 2 $ Year 3 $

What is the additional (nonoperating) cash flow in Year 3? Round your answer to the nearest dollar. $

If the project's cost of capital is 13%, should the chromatograph be purchased?

Answer 1

Initial Investment = Base Price + Modification Cost
Initial Investment = $60,000 + $9,000
Initial Investment = $69,000

Useful Life = 3 years

Depreciation Year 1 = 33% * $69,000
Depreciation Year 1 = $22,770

Depreciation Year 2 = 45% * $69,000
Depreciation Year 2 = $31,050

Depreciation Year 3 = 15% * $69,000
Depreciation Year 3 = $10,350

Book Value at the end of Year 3 = $69,000 - $22,770 - $31,050 - $10,350
Book Value at the end of Year 3 = $4,830

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $15,000 - ($15,000 - $4,830) * 0.35
After-tax Salvage Value = $11,441

Initial Investment in NWC = $3,600

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$69,000 - $3,600
Net Cash Flows = -$72,600

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $24,000 * (1 - 0.35) + 0.35 * $22,770
Operating Cash Flow = $23,570

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $24,000 * (1 - 0.35) + 0.35 * $31,050
Operating Cash Flow = $26,468

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $24,000 * (1 - 0.35) + 0.35 * $10,350
Operating Cash Flow = $19,223

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $3,600 + $11,441
Additional Cash Flows = $15,041

Answer d.

Required Return = 13%

NPV = -$72,600 + $23,570/1.13 + $26,468/1.13^2 + $19,223/1.13^3 + $15,041/1.13^3
NPV = -$7,267

NPV of the chromatograph is negative. So, you should not purchase the chromatograph.