Question

NEW PROJECT ANALYSIS You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $140,000, and it would cost another $35,000 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 $35,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $9,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $47,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent. Negative amount should be indicated by a minus sign. $ What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent. In Year 1 $ In Year 2 $ In Year 3 $ If the WACC is 11%, should the spectrometer be purchased?

Answer 1

Year 0 net cash flow is -$184,000

Year 1 Cash Flow is $51,300

Year 2 Cash Flow is $59,700

Year 3 Cash Flow is $73,600

NPV of the Project is -$35,514.24

Therefore, Spectrometer should not be purchased since NPV is negative

Calculation of Annual Cash Flows of the Project
Particulars	0	1	2	3
Initial Investment
Spectometer Purchase Price	-175000
Investment in Working Capital	-9000
Net Investment (A)	-184000
Operating Cash Flows
Saving in Labor Costs (B)		47000	47000	47000
Depreciation (C ) $175,000 * 33%, 45%, 15%		57750	78750	26250
Profit before Tax (D = B-C)		-10750	-31750	20750
Tax @40% (E = D*40%)		-4300	-12700	8300
Profit After Tax (F = D-E)		-6450	-19050	12450
Add back Depreciation (G = C)		57750	78750	26250
Net Operating Cash Flows (H = F+G)		51300	59700	38700
Terminal Value
Sale Value of Equipment (I)				35000
Less: Book Value of Equipment (J) $175,000 * 7%				12250
Profit on sale (K = I-J)				22750
Tax @40% (L = K*40%)				9100
After tax sale Value (M = I-L)				25900
Recovery of Working Capital (L)				9000
Net Terminal Value (M = K+L)				34900
Total Cash Flows (N = A+H+M)	-184000	51300	59700	73600
Discount Factor @11% (O) 1/(1+11%)^n n=0,1,2,3	1	0.900900901	0.811622433	0.731191381
Discounted Cash Flows (P = N*O)	-184000	46216.21622	48453.85926	53815.68566
NPV	-35514.23886