Question

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 $56,000 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 $126,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $7,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $35,000 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.

3. If the WACC is 10%, should the spectrometer be purchased?

Answer 1

Answer (a):

Year 0 project cash flow:

Year 0 project cash flow = -$343,000

Answer (b):

Project's annual cash flows in Years 1, 2, and 3 are calculated and given below (yellow highlighted):

(Please see next question for this excel with 'show formula')

Answer (c):

No.

The spectrometer should not be purchased

The NPV of the project is = -$116,199.16

As NPV is negative project should be rejected.

Working:

Above excel with 'show formula' is as below: