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Problem 11-07 New-Project Analysis The president of the company you work for has asked you to...

Problem 11-07 New-Project Analysis The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment's basic price is $200,000, and it would cost another $30,000 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $50,000. The MACRS rates for the first 3 years are 0.3333, 0.4445 and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $8,000. The machine would have no effect on revenues, but it is expected to save the firm $60,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 35%. a. What is the Year 0 net cash flow? If the answer is negative, use minus sign. $ b. What are the net operating cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar. Year 1 $ Year 2 $ Year 3 $ c. What is the additional (nonoperating) cash flow in Year 3? Do not round intermediate calculations. Round your answer to the nearest dollar. $

Solutions

Expert Solution

Initial Investment = Base Price + Modification Cost
Initial Investment = $200,000 + $30,000
Initial Investment = $230,000

Useful Life = 3 years

Depreciation Year 1 = 0.3333 * $230,000
Depreciation Year 1 = $76,659

Depreciation Year 2 = 0.4445 * $230,000
Depreciation Year 2 = $102,235

Depreciation Year 3 = 0.1481 * $230,000
Depreciation Year 3 = $34,063

Book Value at the end of Year 3 = $230,000 - $76,659 - $102,235 - $34,063
Book Value at the end of Year 3 = $17,043

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $50,000 - ($50,000 - $17,043) * 0.35
After-tax Salvage Value = $38,465.05

Initial Investment in NWC = $8,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$230,000 - $8,000
Net Cash Flows = -$238,000

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $60,000 * (1 - 0.35) + 0.35 * $76,659
Operating Cash Flow = $65,830.65 or $65,831

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $60,000 * (1 - 0.35) + 0.35 * $102,235
Operating Cash Flow = $74,782.25 or $74,782

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $60,000 * (1 - 0.35) + 0.35 * $34,063
Operating Cash Flow = $50,922.05 or $50,922

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $8,000 + $38,465.05
Additional Cash Flows = $46,465.05 or $46,465


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