Question

New-Project Analysis

The president of your company, MorChuck Enterprises, 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 $78,000, 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 $34,900. The MACRS rates for the first three years are 0.3333, 0.4445 and 0.1481. (Ignore the half-year convention for the straight-line method.) Use of the equipment would require an increase in net working capital (spare parts inventory) of $2,920. The machine would have no effect on revenues, but it is expected to save the firm $30,220 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 25%. 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? (Note: 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 (nonoperating) cash flow in Year 3?

   $ ____

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

   $ ____

5. Should the chromatograph be purchased?

   A. Yes; B. No

Answer 1

V.Sunk cost, Should not be included
a.Initial Investment Outlay = Base Price + Modification cost + Increase in Working Capital
=-78,000-14,000-2,920
(94,920)	since outflow
b.Annual Cash Flows:
	Year 1	2	3
Savings in Cost	30,220	30,220	30,220
Less: Depreciation	30,664	40,894	13,625
Net Savings	-444	-10,674	16,595
Less: Tax @25%	-110.90	-2,668.50	4,148.70
Income after Tax	-332.70	-8,005.50	12,446.10
Add: Depreciation	30,664	40,894	13,625
Operating Cash Flow	30,330.90	32,888.50	26,071.30
Add: After tax salvage value			27,879.30
Recovery of Working capital			2,920
Additional cash flows			30,799
Annual Cash flows	30,330.90	32,888.50	56,870.60
Written down value	6,817
Sale price	34900
Gain on sale	28,083
Tax	7020.7
After tax salvage value	27879.3
c.NPV = Present value of cash inflows – present value of cash outflows
= 30330.90*PVF(11%, 1 year) + 32888.50*PVF(11%, 2 years) + 56870.60*PVF(11%, 3 years) – 94920
681.4721003
Yes, should be purchased (since NPV is positive)