Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $80,000, and it would cost another $20,000 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 $40,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $9,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $38,000 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.

C: If the WACC is 11%, should the spectrometer be purchased? ( Yes or No)

Answer 1

Time line		0	1	2	3
Cost of new machine		-100000
Initial working capital		-9000
=a. Initial Investment outlay		-109000
3 years MACR rate			33.00%	45.00%	15.00%	7.00%
Savings			38000	38000	38000
-Depreciation	=Cost of machine*MACR%		-33000	-45000	-15000	7000	=Salvage Value
=Pretax cash flows			5000	-7000	23000
-taxes	=(Pretax cash flows)*(1-tax)		3000	-4200	13800
+Depreciation			33000	45000	15000
=after tax operating cash flow			36000	40800	28800
reversal of working capital					9000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				24000
+Tax shield on salvage book value	=Salvage value * tax rate				2800
=Terminal year after tax cash flows					35800
b. Total Cash flow for the period		-109000	36000.00	40800.0000	64600.00
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631
Discounted CF=	Cashflow/discount factor	-109000	32432.43243	33114.19528	47234.96323
c. NPV=	Sum of discounted CF=	3781.59

Purchase spectrometer as NPV is positive