Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $210,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $62,000. The equipment would require a $5,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $50,000 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: $   

Answer 1

Year 0 Cash flow      
Cost of machine   -210000  
Tax benefit of full Depreciation   52500  
Depre.*tax rate(210000*25%)      
purchase of inventory   -5000  
___________________________      
Total Cash flow at year 0   -162500  
___________________________      
cash flow at year 0 is   -162500  
      
      
      
Annual Cash flow from Year 1 to 3      
      
Savings in cost   50000  
___________________________      
Operating profit   50000  
less tax @ 25%   -12500  
___________________________      
Annual cash flow   37500  
___________________________      
Year 1   37500  
Year 2   37500  
Year 3   37500  
      

(Depreciation is fully deducted at time of purchase. So no more tax benefit in year 1 to 3)
(Annual cash flows means uniform cash flows)

Calcultion of terminal value  
Salvage value   62000
tax paid @25% of full Capital gain of 62000   -15500
recovery of inventory   5000
  
Terminal inflow   51500
   
Cash flows for year 3= 51500+37500=   89000
  

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