Question

You must evaluate the purchase of a spectiomater for the R&D deparmet. the base price is $140,000 and it would cost another $30,000 to modifly the equpment for speical use by the firm. the equipment falls into the MACRS 3years class and would be sold after 3 years for 60,000. The applicable deprecation rates are 33% 45% 15 % and 7% as disccussed in Appendix 12A the equpiment would require an $8,000 increase in net operating working captial (spare parts inventory) the project would have no effecrs on revenues. nut it should save the firm $50,000 per year in before tax labor costs. the firms marginal ferderal plus state tax rate is 40% the firm WACC hurdle rate or required rate of return is 12%

what is the project from the liquidation of net operating working capital (spare parts inventory ) in year 3?

Answer 1

a. The net cost of the spectrometer is 170,000 ( 140,000 plus 30,000)
The Year 0 project cash flow is 178,000. ( 170,000 plus spare parts inventory of 8000)

b. Project Net cash flow Year 1 is: $45587
Cost saving before tax 50000
Less Depreciation 36300 ( 170,000 minus salvage value 60,000) x .33 =36,300)
Less Amortization Spare Parts 2667 ( 8000 divided by 3 =2667)
Net Income after depreciation/amortization 11033
Income Tax 40% 4413
Net Income after Tax 6620
Add: non cash charges depreciation/amortization 38967
Cash flow generated year 1 45587


Project Net cash flow Year 2 is: $ 50867
Cost saving before tax 50000
Less Depreciation 49500 ( 170,000 minus salvage value 60,000) x .45 = 49500 )
Less Amortization Spare Parts 2667 ( 8000 divided by 3 =2667)
Net Income/loss after depreciation/amortization -2167
Income Tax shield on loss 40% 867
Net Income/loss after Tax shield -1300
Add: non cash charges depreciation/amortization 52167
Cash flow generated year 2 50867

Project Net cash flow Year 3 is: $ 76747

Cost saving before tax 50000
Less Depreciation 16500 ( 170,000 minus salvage value 60,000) x .15 =16500)
Less Amortization Spare Parts 2667 ( 8000 divided by 3 =2667)
Net Income after depreciation/amortization 30833
Gain onSale of equipment at year 3 52300 ( $ 60000 minus book value of equipment7700)
Total Income 83133
Income Tax 40% 33253
Net Income after Tax 49880
Add: non cash charges depreciation/amortization 19167
Total income after tax 69l047
add: Sale of equipment book value 7700
Cash flow Generated Year 3 76747

c. Based on Net Present value of the cash flow discounted at 12%, the spectrometer should not be purchased as the NPV is negative at $-42120


cash flow year 0 -178000 x 1.0 Present value factor of $1 at 12% at year 0= -178000
Cash flow year 1 45587 x 0.892857143 =40702
Cash Flow year 2 50867 x0.797193878= 40551
Cash Flow year 3 76747 x 0.711780248= 54627

Net Present value $ -42120

Present value factor at 12% at end of year 1 = 1/1.12=0.892857143
Present value factor of 12% at end of year 2 =0.892857143/1.12=0.797193878
Present value factor of 12% at end of year 3 =0.797193878/1.12=0.711780248