Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $90,000, and it would cost another $13,500 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 $40,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $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 $54,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

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.

   In Year 1 $

   In Year 2 $

   In Year 3 $

Answer 1

Question a:

Year 0 net cash flow is -$117,500

Question b:

Annual Cash Flow in year 1 is $46,062

Annual Cash Flow in year 2 is $51,030

Annual Cash Flow in year 3 is $79,808

Calculation of Annual Cash Flows of the Project
Particulars	0	1	2	3
Initial Investment
Spectometer Purchase Price	-103500
Investment in Working Capital	-14000
Net Investment (A)	-117500
Operating Cash Flows
Saving in Labor Costs (B)		54000	54000	54000
Depreciation (C ) $103,500 * 33%, 45%, 15%		34155	46575	15525
Profit before Tax (D = B-C)		19845	7425	38475
Tax @40% (E = D*40%)		7938	2970	15390
Profit After Tax (F = D-E)		11907	4455	23085
Add back Depreciation (G = C)		34155	46575	15525
Net Operating Cash Flows (H = F+G)		46062	51030	38610
Terminal Value
Sale Value of Equipment (I)				40500
Less: Book Value of Equipment (J) $103,500 * 7%				7245
Profit on sale (K = I-J)				33255
Tax @40% (L = K*40%)				13302
After tax sale Value (M = I-L)				27198
Recovery of Working Capital (L)				14000
Net Terminal Value (M = K+L)				41198
Total Cash Flows (N = A+H+M)	-117500	46062	51030	79808