Question

Intro You're evaluating a new electron microscope for the QA (quality assurance) unit. The microscope will cost $24,000 to buy and another $2,000 to install, and will be sold for $1,800 after 3 years. It falls into the 3-year MACRS class, with depreciation rates as follows: Year 1 2 3 4 Depreciation rate 33% 45% 15% 7% The microscope will require an inventory of spare parts worth $5,000. The equipment will not increase revenue, but will save the company $12,000 in labor costs each year. Your company's marginal tax rate (federal plus state) is 34% and the appropriate cost of capital for this project is 13%

Attempt 1/5 for 10 pts. Part 1 What is the initial (year-0) free cash flow from the project? Choose the right sign.

Attempt 1/5 for 10 pts. Part 2 What is the free cash flow in year 1?

Attempt 1/5 for 10 pts. Part 3 What is the free cash flow in year 2?

Attempt 1/5 for 10 pts.Part 4 What is the after-tax salvage value at the end of year 3?

Attempt 1/5 for 10 pts. Part 5 What is the free cash flow in year 3?

Attempt 1/5 for 10 pts. Part 6 What is the NPV of this project?

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $24,000 + $2,000
Initial Investment = $26,000

Useful Life = 3 years

Depreciation Year 1 = 33% * $26,000
Depreciation Year 1 = $8,580

Depreciation Year 2 = 45% * $26,000
Depreciation Year 2 = $11,700

Depreciation Year 3 = 15% * $26,000
Depreciation Year 3 = $3,900

Answer 1.

Year 0:

Initial Investment in NWC = $5,000

Free Cash Flows = Initial Investment + Initial Investment in NWC
Free Cash Flows = -$26,000 - $5,000
Free Cash Flows = -$31,000

Answer 2.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $12,000 * (1 - 0.34) + 0.34 * $8,580
Operating Cash Flow = $10,837.20

Free Cash Flows = Operating Cash Flow
Free Cash Flows = $10,837.20

Answer 3.

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $12,000 * (1 - 0.34) + 0.34 * $11,700
Operating Cash Flow = $11,898.00

Free Cash Flows = Operating Cash Flow
Free Cash Flows = $11,898.00

Answer 4.

Book Value at the end of Year 3 = $26,000 - $8,580 - $11,700 - $3,900
Book Value at the end of Year 3 = $1,820

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $1,800 - ($1,800 - $1,820) * 0.34
After-tax Salvage Value = $1,806.80

Answer 5.

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $12,000 * (1 - 0.34) + 0.34 * $3,900
Operating Cash Flow = $9,246.00

Free Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Free Cash Flows = $9,246 + $5,000 + $1,806.80
Free Cash Flows = $16,052.80

Answer 6.

Required Return = 13%

NPV = -$31,000 + $10,837.20/1.13 + $11,898/1.13^2 + $16,052.80/1.13^3
NPV = -$966.28

NPV of the project is -$966.28