Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $160,000, and it would cost another $32,000 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 $56,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $13,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $76,000 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 13%, should the spectrometer be purchased?
   -Select-Yes No

Answer 1

a.Initial Investment Outlay = Base Price + Modification cost + Increase in Working Capital

= 160,000+32,000+13,000

= $205,000

b.Annual Cash Flows:

	Year 1	2	3
Savings in Cost	76,000	76,000	76,000
Less: Depreciation	63,360	86,400	28,800
Net Savings	12,640	-10,400	47,200
Less: Tax @40%	5,056	-4,160	18,880
Income after Tax	7,584	-6,240	28,320
Add: Depreciation	63,360	86,400	28,800
Cash Flow	70,944	80,160	57,120
Add: After tax salvage value			38,976
Recovery of Working capital			13,000
Cash Flow	70,944	80,160	109,096

Note: Written down value of machine = 192,000*7% = $13,440

Sale Price = $56,000

Gain on Sale = $42,560

Tax on Gain = $17,024

After tax salvage value = 56,000 – 17,024 = $38,976

c.NPV = Present value of cash inflows – present value of cash outflows

= 70,944*PVF(13%, 1 year) + 80,160*PVF(13%, 2 years) + 109,096*PVF(13%, 3 years) – 205,000

= 70,944*0.885 + 80,160*0.783 + 109,096*0.693 - 205,000

= -$3,845.752

No, should not be purchased (since NPV is negative)