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. The equipment's basic price is $200,000, and it would cost another $50,000 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 $90,000. 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 $10,000. The machine would have no effect on revenues, but it is expected to save the firm $60,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40%.

1. What is the Year 0 net cash flow? If the answer is negative, use parentheses.
   $
2. 
   
3. 
   
4. 
   
5. What are the net operating cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar.

   Year 1	$
   Year 2	$
   Year 3	$

6. 
   
7. What is the additional (nonoperating) cash flow in Year 3? Do not round intermediate calculations. Round your answer to the nearest dollar.
   $
8. 
   
9. 
   
10. 
    
11. If the project's cost of capital is 12%, should the chromatograph be purchased?
    -Select-Yes No

Answer 1

Initial Investment = Base Price + Modification Cost
Initial Investment = $200,000 + $50,000
Initial Investment = $250,000

Useful Life = 3 years

Depreciation Year 1 = 33.33% * $250,000
Depreciation Year 1 = $83,325

Depreciation Year 2 = 44.45% * $250,000
Depreciation Year 2 = $111,125

Depreciation Year 3 = 14.81% * $250,000
Depreciation Year 3 = $37,025

Book Value at the end of Year 3 = $250,000 - $83,325 - $111,125 - $37,025
Book Value at the end of Year 3 = $18,525

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $90,000 - ($90,000 - $18,525) * 0.40
After-tax Salvage Value = $61,410

Initial Investment in NWC = $10,000

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$250,000 - $10,000
Net Cash Flows = -$260,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $60,000 * (1 - 0.40) + 0.40 * $83,325
Operating Cash Flow = $69,330

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $69,330

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $60,000 * (1 - 0.40) + 0.40 * $111,125
Operating Cash Flow = $80,450

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $80,450

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $60,000 * (1 - 0.40) + 0.40 * $37,025
Operating Cash Flow = $50,810

Additional Cash Flow = NWC recovered + After-tax Salvage Value
Additional Cash Flow = $10,000 + $61,410
Additional Cash Flow = $71,410

Net Cash Flows = Operating Cash Flow + Additional Cash Flow
Net Cash Flows = $50,810 + $71,410
Net Cash Flows = $122,220

Required Return = 12%

NPV = -$260,000 + $69,330/1.12 + $80,450/1.12^2 + $122,220/1.12^3
NPV = -$46,970.18

So, the chromatograph should not be purchased as its NPV is negative.