Question

In: Finance

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price...

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $280,000, and it would cost another $70,000 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 $70,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $7,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $21,000 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 10%, should the spectrometer be purchased?
    yes or no

Solutions

Expert Solution

Time line 0 1 2 3
Cost of new machine -350000
Initial working capital -7000
=a. Initial Investment outlay -357000
3 years MACR rate 33.00% 45.00% 15.00% 7.00%
Savings 21000 21000 21000
-Depreciation =Cost of machine*MACR% -115500 -157500 -52500 24500 =Salvage Value
=Pretax cash flows -94500 -136500 -31500
-taxes =(Pretax cash flows)*(1-tax) -56700 -81900 -18900
+Depreciation 115500 157500 52500
=after tax operating cash flow 58800 75600 33600
reversal of working capital 7000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 42000
+Tax shield on salvage book value =Salvage value * tax rate 9800
=Terminal year after tax cash flows 58800
b.Total Cash flow for the period -357000 58800 75600 92400
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331
Discounted CF= Cashflow/discount factor -357000 53454.55 62479.34 69421.488
c. NPV= Sum of discounted CF= -171644.63

Reject as NPV is negative


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