Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $200,000, and it would cost another $50,000 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 $100,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $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 $71,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

A.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.
$

B.

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
=-200,000-50,000-11000
(261,000)	since outflow
b.Annual Cash Flows:
	Year 1	2	3
Savings in Cost	71,000	71,000	71,000
Less: Depreciation	82,500	112,500	37,500
Net Savings	-11,500	-41,500	33,500
Less: Tax @40%	-4,600.00	-16,600.00	13,400.00
Income after Tax	-6,900.00	-24,900.00	20,100.00
Add: Depreciation	82,500	112,500	37,500
Operating Cash Flow	75,600.00	87,600.00	57,600.00
Add: After tax salvage value			67,000.00
Recovery of Working capital			11,000
Additional cash flows			78,000
Annual Cash Flows	75,600.00	87,600.00	135,600.00
Written down value	17,500
Sale price	100000
Gain on sale	82,500
Tax	33000
After tax salvage value	67000