Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $250,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $62,000. 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 $28,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 25%.

1. 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.
   $  
2. 
   
3. 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: $  
4. 
   
5. If the WACC is 10%, should the spectrometer be purchased?
   -Select-YesNoItem 5

Answer 1

a.Initial Investment Outlay = Base Price + Modification cost + Increase in Working Capital - Tax savings on Depreciation
=250,000+11000-250,000*25%
198,500	since outflow
b.Annual Cash Flows:
	Year 1	2	3
Savings in Cost	28,000	28,000	28,000
Less: Depreciation	0	0	0
Net Savings	28,000	28,000	28,000
Less: Tax @25%	7,000.00	7,000.00	7,000.00
Income after Tax	21,000.00	21,000.00	21,000.00
Add: Depreciation	0	0	0
Operating Cash Flow	21,000.00	21,000.00	21,000.00
Add: After tax salvage value			46,500.00
Recovery of Working capital			11,000
Additional cash flows			57,500
Annual Cash Flow	21,000.00	21,000.00	78,500.00
Written down value	0
Sale price	62000
Gain on sale	62,000
Tax	15500
After tax salvage value	46500
c.NPV = Present value of cash inflows – present value of cash outflows
= 21000*PVF(10%, 1 year) + 21000*PVF(10%, 2 years) + 78500*PVF(10%, 3 years) – 198500
-103075.5071
No, should not be purchased (since NPV is negative)