Question

Colsen Communications is trying to estimate the first-year net operating cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project:

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $60,000, and it would cost another $9,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $15,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $13,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $40,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 35%. 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 cent. $   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 cent. Year 1: $   Year 2: $   Year 3: $   If the WACC is 14%, should the spectrometer be purchased?

The company has a 40% tax rate, and its WACC is 11%.

Write out your answers completely. For example, 13 million should be entered as 13,000,000.

1. What is the project's operating cash flow for the first year (t = 1)? Round your answer to the nearest dollar.
   $  
2. 
   
3. If this project would cannibalize other projects by $2 million of cash flow before taxes per year, how would this change your answer to part a? Round your answer to the nearest dollar.
   The firm's OCF would now be $  
4. 
   
5. Ignore Part b. If the tax rate dropped to 30%, how would that change your answer to part a? Round your answer to the nearest dollar.
   The firm's operating cash flow would -Select-increasedecreaseItem 3 by $  

Answer 1

a.Initial Investment Outlay = Base Price + Modification cost + Increase in Working Capital
=60000+9000+13000
82,000
b.Annual Cash Flows:
	Year 1	2	3
Savings in Cost	40,000	40,000	40,000
Less: Depreciation	22,770	31,050	10,350
Net Savings	17,230	8,950	29,650
Less: Tax @35%	6,030.50	3,132.50	10,377.50
Income after Tax	11,199.50	5,817.50	19,272.50
Add: Depreciation	22,770	31,050	10,350
Operating Cash Flow	33,969.50	36,867.50	29,622.50
Add: After tax salvage value			11,440.50
Recovery of Working capital			13,000
Additional cash flows			24,441
Annual Cash Flows	33,969.50	36,867.50	54,063.00
Written down value	4,830
Sale price	15000
Gain on sale	10,170
Tax	3559.5
After tax salvage value	11440.5
c.NPV = Present value of cash inflows – present value of cash outflows
= 33969.50*PVF(14%, 1 year) + 36867.50*PVF(14%, 2 years) + 54063*PVF(14%, 3 years) – 82000
12657.1362
Yes, should be purchased (since NPV is positive)