Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $180,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $59,000. The equipment would require a $14,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $56,000 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 14%, should the spectrometer be purchased?
   _______ YES/NO

Answer 1

Time line		0	1	2	3
Cost of new machine		-180000
Initial working capital		-14000
=a. Initial Investment outlay		-194000
						100.00%
Savings			56000	56000	56000
-Depreciation	Cost of equipment/no. of years		-60000	-60000	-60000	0	=Salvage Value
=Pretax cash flows			-4000	-4000	-4000
-taxes	=(Pretax cash flows)*(1-tax)		-3000	-3000	-3000
+Depreciation			60000	60000	60000
=b. after tax operating cash flow			57000	57000	57000
reversal of working capital					14000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				44250
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					58250
Total Cash flow for the period		-194000	57000	57000	115250
Discount factor=	(1+discount rate)^corresponding period	1	1.14	1.2996	1.481544
Discounted CF=	Cashflow/discount factor	-194000	50000	43859.64912	77790.46724
c. NPV=	Sum of discounted CF=	-22349.88

Reject project as NPV is negative