Question

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?

Answer 1