Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $90,000, and it would cost another $22,500 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 $31,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $14,000 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 35%.

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 cent.
   $  
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 cent.
   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
=90,000+22500+14000
126,500	since outflow
b.Annual Cash Flows:
	Year 1	2	3
Savings in Cost	74,000	74,000	74,000
Less: Depreciation	37,125	50,625	16,875
Net Savings	36,875	23,375	57,125
Less: Tax @35%	12,906.25	8,181.25	19,993.75
Income after Tax	23,968.75	15,193.75	37,131.25
Add: Depreciation	37,125	50,625	16,875
Operating Cash Flow	61,093.75	65,818.75	54,006.25
Add: After tax salvage value			23,231.25
Recovery of Working capital			14,000
Additional cash flows			37,231
Annual Cash Flow	61,093.75	65,818.75	91,237.50
Written down value	7,875
Sale price	31500
Gain on sale	23,625
Tax	8268.75
After tax salvage value	23231.25
c.NPV = Present value of cash inflows – present value of cash outflows
= 61093.75*PVF(10%, 1 year) + 65818.75*PVF(10%, 2 years) + 91237.50*PVF(10%, 3 years) – 126500
51983.51803
Yes, should be purchased (since NPV is positive)