Question

NEW PROJECT ANALYSIS

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $120,000, and it would cost another $18,000 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 $36,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $6,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $60,000 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?

Answer 1

Answer a:

Year 0 cash flow = - cost of spectrometer - modification cost - networking capital required

= -120000 - 18000 - 6000

= -$144,000.00

  Year 0 project cash flow = - $144,000.00

Answer b:

Cash flow in Year 1 = $54,216.00

Cash flow in Year 2 = $60,840.00

Cash flow In Year 3 = $75,744.00

Workings:

Answer c:

Yes, Spectrometer should be purchases.

The NPV of this project is positive at $12,475.85

Working: