Question

NEW PROJECT ANALYSIS

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $280,000, and it would cost another $42,000 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 $70,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $48,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

1. 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.
   $

2. 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 $

3. If the WACC is 11%, should the spectrometer be purchased?
   -Select-YesNo

Answer 1

a.Initial Investment Outlay = Base Price + Modification cost + Increase in Working Capital

= 280,000+42,000 +8,000

= -$330,000 since outflow

b.Annual Cash Flows:

	Year 1	2	3
Savings in Cost	48,000	48,000	48,000
Less: Depreciation	106,260	144,900	48,300
Net Savings	(58,260)	(96,900)	(300)
Less: Tax @40%	(23,304)	(38,760)	(120)
Income after Tax	(34,956)	(58,140)	(180)
Add: Depreciation	106,260	144,900	48,300
Cash Flow	71,304	86,760	48,120
Add: After tax salvage value			51,016
Recovery of Working capital			8,000
Cash Flow	71,304	86,760	107,136

Note: Written down value of machine = 322000*7% = $22,540

Sale Price = $70,000

Gain on Sale = $47,460

Tax on Gain = $18,984

After tax salvage value = 70,000– 18,984= $51,016

c.NPV = Present value of cash inflows – present value of cash outflows

= 71,304*PVF(11%, 1 year) + 86,760*PVF(11%, 2 years) + 107,136*PVF(11%, 3 years) – 330,000

= 71,304*0.901 + 86,760*0.812 + 107,136*0.731 – 330,000

= -$116,989.56

No, should not be purchased (since NPV is negative)