Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $60,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $25,000. 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 $27,000 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 12%, should the spectrometer be purchased?
   -Select-YesNo

Answer 1

Time line		0	1	2	3
Cost of new machine		-60000
Initial working capital		-7000
=a. Initial Investment outlay		-67000
						100.00%
Savings			27000	27000	27000
-Depreciation	Cost of equipment/no. of years		-20000	-20000	-20000	0	=Salvage Value
=Pretax cash flows			7000	7000	7000
-taxes	=(Pretax cash flows)*(1-tax)		5250	5250	5250
+Depreciation			20000	20000	20000
=b. after tax operating cash flow			25250	25250	25250
reversal of working capital					7000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				18750
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					25750
Total Cash flow for the period		-67000	25250	25250	51000
Discount factor=	(1+discount rate)^corresponding period	1	1.12	1.2544	1.404928
Discounted CF=	Cashflow/discount factor	-67000	22544.64286	20129.14541	36300.79264
c. NPV=	Sum of discounted CF=	11974.58

Accept project as NPV is positive