You must evaluate the purchase of a spectrometer for a firm. The base price is $140,000...

You must evaluate the purchase of a spectrometer for a firm. The base price is $140,000 and it would cost another $30,000 to modify the equipment for special use by the firm.

The equipment will be depreciated to zero value over the 3 years using prime cost (straight line) method. The machine would be sold after 3 years for $60,000. The machine would require a $8,500 increase in net working capital and fully recover at the end of its 3-year life. The equipment should save the firm $50,000 per year in before-tax labor costs.

Below shows the forecasted sales revenues, variable cost and fixed cost.

	Year 1	Year 2	Year 3
Sales quantity (units)	4,000	5,000	5,500
Selling price per unit	$4	$4	$4
Fixed cost of production (per year)	$1,500	$1,500	$1,500
Variable cost of production (per unit)	$1.1	$1.1	$1.1

The marginal tax rate is 40% and the discount rate is 10%.

What is the net present value (NPV) of the proposed project?

Solutions

Expert Solution

(a.) Calculation of Net present value (NPV) of the proposed project :

	Year 0	Year 1	Year 2	Year 3

Initial Investment ( 140000 + 30000)	170000

Saving in Pre tax Labour Cost		50000	50000	50000

*Sales (Quantity Selling Price)**		16000	20000	22000

*Less :Variable cost of Production (Quantity Variable cost per unit)**		4400	5500	6050

Less :Fixed Cost of Production		1500	1500	1500

Less : Depreciation (170000 / 3 )		56666.67	56666.67	56666.67


Earning before taxes		3433.333	6333.333	7783.333

Taxes @ 40%		-1373.33	-2533.33	-3113.33

Earnings After Taxes		2060	3800	4670

Add : Depreciation		56666.67	56666.67	56666.67

Plus : Salvage Value				60000

Less : tax on salvage @ 40%				24000

NWC	8500

Plus : Recapture of NWC				8500

Operating Cash Flows	178500	58727	60467	105836.7

PV Factor @ 10%	1	0.909091	0.826446	0.751315

PV of Net Cash flows (Inflow)		53387.88	49972.45	79516.65
PV of Net Cash flows (Outflow)	178500

The net present value (NPV) of this project is		= $ 4376.9847 or $ 4376.98

NPV = PV of cash inflow - PV of cash outflow
= 182879.9847- 178500
= $ 4376.9847 or $ 4376.98

Working Note :

Book Value = 0 (Since it is fully depreciated
Gain on Sale = Salvage Value - Book Value
= 60000- 0
= 60000
*Tax on Gain on Sale = 60000 0.4 = 24000**

jeff jeffy answered 1 year ago

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