Question

NEW PROJECT ANALYSIS

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $300,000, and it would cost another $60,000 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 $105,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $5,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $29,000 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 $

3. If the WACC is 12%, should the spectrometer be purchased?
   -Select-YesNoItem 5

Answer 1

Req a:
Cash outflows in year-0
Equipment cost			-300000
Add: Modification cost			-60000
Total equipment cost				-360000
Working capitall investment				-5000
Cash outflows in Year-0				-365000
Cashflows
			Year-1	Year-2	Year-3
Savings in ccost			29000	29000	29000
Less: Tax @ 40%			11600	11600	11600
After tax savings			17400	17400	17400
Depreciation			118800	162000	54000
Tax shield @ 40%			47520	64800	21600
Annual cashflows			64920	82200	39000
After Tax salvage:
Sales value			105000
Book value (360000*7%)			25200
Gain on sales			79800
Tax on Gain @ 40%			31920
After Tax salvage = 105000-31920 = 73080
NPV:
			Year-0	Year-1	Year-2	Year-3
Cashflows			-365000	64920	82200	39000
After tax salvage						73080
Net cashflows			-365000	64920	82200	112080
PVF at 12%			1	0.892857	0.797194	0.71178
Present value of CF			-365000	57964.29	65529.34	79776.33
NPV			-161730