Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $70,000, and it would cost another $10,500 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 $17,500. 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 $36,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

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.

What are the project's annual cash flows in Years 1, 2, and 3?

Answer 1

A)Initial Investment :

Capital cost of equipment	-(70000+10500)= -80500
Investment in net operating working capital	- 7000
Investment at year 0 (cash flow at year0 )	- 87500

B)

	1	2	3
Saving in Labor cost	36000	36000	36000
less:Depreciation	-26565     (80500*.33)	-36225   (80500*.45)	-12075    (80500*.15)
Income before tax	9435	-225	23925
less:Tax	-3774     (9435*.40)	90       (225*.40)	-9570      (23925*.40)
Net Income	5661	-135	14355
Add:Depreciation (non cash)	26565	36225	12075
After tax sale value			12754
Working capital released			7000
Cash Flow	32226	36090	46184

**In year 2 ,Tax saving will be available due to loss of 225

**Book Value at year 3 Cost- Accumulated depreciation

         = 80500 - (26565+36225+12075)

          = 80500- 74865

          = 5635

Gain On sale =sale value -Book value

= 17500 -5635

   = 11865

Tax on Gain = 11865*.40 = 4746

After tax sale value = sale value -taxes

                      = 17500 -4746

                    = 12754