Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $140,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $57,000. The equipment would require a $13,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $23,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 25%.

1. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Enter your answer as a positive value. Round your answer to the nearest dollar.
   $  
2. 
   
3. What are the project's annual cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar.
   Year 1: $  
   Year 2: $  
   Year 3: $  
4. 
   
5. If the WACC is 10%, should the spectrometer be purchased?

Answer 1

Solution:-

To Calculate Year 0 Project Cash Flows-

Year 0 Cash Flow = -Initial Investment - Net Working Capital

Year 0 Cash Flow = -$140,000 - $13,000

Year 0 Cash Flow = -$153,000

To Calculate Annual Cash Flows for Year 1,2,3-

Cash Flow are calculate in Below Diagram.

Year 1 = $28,916.67

Year 2 = $28,916.67

Year 3 = $84,666.67

To Calculate NPV of the Project-

NPV of the Project is -$39,203.

NPV of the Project is accepted when it is greater than or equal to zero. Hence, in the Given Case, NPV is Negative. So, Spectrometer cannot be purchased.

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