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 $74,000, and it would cost another $14,000 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 $33,500. The MACRS rates for the first 3 years are 0.3333, 0.4445 and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $3,500. The machine would have no effect on revenues, but it is expected to save the firm $24,220 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40%. Cash outflows and negative NPV value, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest dollar.

1. What is the Year-0 net cash flow?

   $  

2. What are the net operating cash flows in Years 1, 2, and 3? Do not include recovery of NWC or salvage value in Year 3's calculation here.

   Year 1:	$
   Year 2:	$
   Year 3:	$

3. What is the additional cash flow in Year 3 from NWC and salvage?

   $  

4. If the project's cost of capital is 11%, what is the NPV of the project? .

   $  

   Should the chromatograph be purchased?

   -Select-YesNoItem 7

Answer 1

The cash flows and NPV are calculated as below :

book value of equipment at end of 3 years = cost - cumulative depreciation = $88,000 - $81,479 = $6,521

tax on profit on sale of equipment = ($33,500 - $6,521) * 40% = $10,792

Year 3 cash flow = net cash flow + salvage value after tax + return of working capital

a]

Year 0 net cash flow = $88,000 + $3,500 = $91,500

b]

net operating cash flow in year 1 = $26,264

net operating cash flow in year 2 = $30,178

net operating cash flow in year 3 = $19,745

c]

additional cash flow from NWC and salvage is $14,292

d]

NPV of project is -$18,458 (the NPV is negative)

The chromatograph should not be purchased as the NPV is negative