Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $160,000, and it would cost another $32,000 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 $72,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $6,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $37,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

1. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent. Negative amount should be indicated by a minus sign.
   $

2. What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent.

   In Year 1 $

   In Year 2 $

   In Year 3 $

Answer 1

a.Initial Investment Outlay = Base Price + Modification cost + Increase in Working Capital
=-160,000-32000-6000
(198,000)	since outflow
b.Annual Cash Flows:
	Year 1	2	3
Savings in Cost	37,000	37,000	37,000
Less: Depreciation	63,360	86,400	28,800
Net Savings	-26,360	-49,400	8,200
Less: Tax @40%	-10,544.00	-19,760.00	3,280.00
Income after Tax	-15,816.00	-29,640.00	4,920.00
Add: Depreciation	63,360	86,400	28,800
Operating Cash Flow	47,544.00	56,760.00	33,720.00
Add: After tax salvage value			48,576.00
Recovery of Working capital			6,000
Additional cash flows			54,576
Annual Cash Flows	47,544.00	56,760.00	88,296.00
Written down value	13,440
Sale price	72000
Gain on sale	58,560
Tax	23424
After tax salvage value	48576