Question

In: Accounting

The president of the company you work for has asked you to evaluate the proposed acquisition...

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. It will be a 4-year project.

  • The equipment’s basic price is $70,000, and it would cost another $15,000 to modify it for special use by your firm.

  • Use of the equipment would require an increase in net operating working capital (spare parts inventory) of $4,000.

  • The machine would have no effect on revenues, but it is expected to save the firm $20,000 per year (for 4 years) in before-tax operating costs, mainly labor.

  • The chromatograph, which falls into the MACRS 3-year class (such assets are depreciated over 4 years as discussed in Appendix 13A). The MACRS rates for the 4 years are 33.33%, 44.45%, 14.81%, and 7.41%.

  • It would be sold after 4 years for $31,000.

If the firm’s marginal federal-plus-state tax rate is 40%,

  • What is the Year 0 cash flow?

  • What are the operating cash flows in Years 1, 2, 3, and 4?

  • What is the additional (terminal) cash flow in Year 4?

  • If the project’s cost of capital is 10%, should the chromatograph be purchased?

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