Question

ou must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $110,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $53,000. The equipment would require an $11,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $74,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 25%. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Enter your answer as a positive value. Round your answer to the nearest dollar. $ What are the project's annual 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: $ If the WACC is 10%, should the spectrometer be purchased?

Answer 1

a: Year 0 cash flow is -$93,500

b: Annual cash flow for year 1 is $55,500

  Annual cash flow for year 2 is $55,500

  Annual cash flow for year 3 is $106,250

c: NPV of the project is $82,649.51

Spectrometer should be purchase since NPV of the project is positive

Calculation of NPV of the Project
Particulars	0	1	2	3
Initial Investment
Spectometer Base Price (A)	-110000
Working Capital (B)	-11000
Net Investment (C = A+B)	-121000
Operating Cashflows
Decrease in operating costs (D)		74000	74000	74000
Less: Depreciation (E) ($110,000 *100%)	110000	0.00	0.00	0.00
Profit Before Tax (F = D-E)	-110000	74000	74000	74000
Less: Tax @25%(G = F*25%)	-27500	18500	18500	18500
Profit After Tax (H = F-G)	-82500	55500	55500	55500
Addback Depreciation (I = E)	110000	0.00	0.00	0.00
Net Operating Cashflows (J = H+I)	27500	55500.00	55500.00	55500
Salvage Value
Sale value of Spectometer (K)				53000
Less: Tax @25% (L= K*25%)				13250
After tax sale value (M = K-L)				39750
Recovery of net working capital (N)				11000
Net Terminal Value (O = M+N)				50750
Total Cash Flows (P = C+J+O)	-93500	55500	55500	106250
Discount Factor @10% (Q ) 1/(1+10%)^n n=0,1,2,3	1	0.909090909	0.82644628	0.7513148
Discounted Cash Flows (R = P*Q)	-93500	50454.54545	45867.7686	79827.198
NPV of the project	82649.5116