Question

New-Project Analysis

The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment's basic price is $76,000, and it would cost another $18,500 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $30,600. The MACRS rates for the first 3 years are 0.3333, 0.4445 and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,360. The machine would have no effect on revenues, but it is expected to save the firm $29,440 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40%. Cash outflows and negative NPV value, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest dollar.

1. What is the Year-0 net cash flow?

   $  

2. What are the net operating cash flows in Years 1, 2, and 3? Do not include recovery of NWC or salvage value in Year 3's calculation here.

   Year 1:	$
   Year 2:	$
   Year 3:	$

3. What is the additional cash flow in Year 3 from NWC and salvage?

   $  

4. If the project's cost of capital is 11%, what is the NPV of the project? .

   $  

   Should the chromatograph be purchased?

   -Select-YesNo

Answer 1

Initial Investment = Base Price + Modification Cost
Initial Investment = $76,000 + $18,500
Initial Investment = $94,500

Useful Life = 3 years

Depreciation Year 1 = 0.3333 * $94,500
Depreciation Year 1 = $31,496.85

Depreciation Year 2 = 0.4445 * $94,500
Depreciation Year 2 = $42,005.25

Depreciation Year 3 = 0.1481 * $94,500
Depreciation Year 3 = $13,995.45

Book Value at the end of Year 3 = $94,500.00 - $31,496.85 - $42,005.25 - $13,995.45
Book Value at the end of Year 3 = $7,002.45

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $30,600.00 - ($30,600.00 - $7,002.45) * 0.40
After-tax Salvage Value = $21,160.98

Initial Investment in NWC = $4,360

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$94,500 - $4,360
Net Cash Flows = -$98,860

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $29,440 * (1 - 0.40) + 0.40 * $31,496.85
Operating Cash Flow = $30,262.74 or $30,263

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $29,440 * (1 - 0.40) + 0.40 * $42,005.25
Operating Cash Flow = $34,466.10 or $34,466

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $29,440 * (1 - 0.40) + 0.40 * $13,995.45
Operating Cash Flow = $23,262.18 or $23,262

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $4,360 + $21,160.98
Additional Cash Flows = $25,520.98 or $25,521

Answer d.

Cost of Capital = 11%

NPV = -$98,860 + $30,263/1.11 + $34,466/1.11^2 + $23,262/1.11^3 + $25,521/1.11^3
NPV = -$7,953

NPV of the spectrometer is negative. So, you should not purchase the spectrometer.