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 $100,000, and it would cost another $25,000 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 $35,000. 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 $4,000. The machine would have no effect on revenues, but it is expected to save the firm $40,000 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 minus sign.
   $
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 14%, should the chromatograph be purchased?

Answer 1

Ans.

What is the Year 0 net cash flow? If the answer is negative, use minus sign.

Basic Price = $100,000

Modification = $25,000

NOWC (Inventory) = $4,000

Net Cost $129,000

Year-0 net cash flow - $ 129,000 (outflow)

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.

Net Operating Cash Flows	Year 1	Year 2	Year 3
After tax savings ( 40,000 * 60%)	$             24,000.00	$          24,000.00	$   24,000.00
Tax shield on Depreciation ( $ 100,000 + $ 25,000 ) * Depreciation rate * tax rate	$             16,665.00	$          22,225.00	$     7,405.00
Net Operating Cash Flow	$             40,665.00	$          46,225.00	$   31,405.00

What is the additional (nonoperating) cash flow in Year 3? Do not round intermediate calculations. Round your answer to the nearest dollar.

Additional (non operating) cash flows in year 3
After tax salvage value *	$                   24,705
Recovery of Working capital	$                     4,000
Additional cash flow	$                   28,705

Working Note:

After tax salvage value *
Cost ( $ 100,000 + $ 25,000)	$                 125,000
Less : Accumulated Depreciation ( $ 125,000 * (0.3333+0.4445+0.1481)	$                 115,738
Book value	$                     9,263
Sale Value	$                   35,000
Gain on Sale	$                   25,738
Tax on gain ( 25,738 * 40%)	$                   10,295
After tax salvage value ( $ 35,000 - $ 10,295)	$                   24,705

If the project's cost of capital is 14%, should the chromatograph be purchased?

Calculation of NPV	Year 0	Year 1	Year 2	Year 3
Initial Investment	$        (129,000.00)
Net Operating Cash Flows		$          40,665.00	$   46,225.00	$      31,405.00
Additional (non operating) cash flows in year 3				$      28,705.00
Net Cash Flow	$        (129,000.00)	$          40,665.00	$   46,225.00	$      60,110.00
Discounting Factor @ 14%	1	0.877192982	0.769467528	0.674971516
Present Value	$        (129,000.00)	$          35,671.05	$   35,568.64	$      40,572.54
Net Present Value	$           (17,187.77)

Net Present Value = - $ 17,188

As the Net Present Value is negative, chromatograph should not be purchased.