chapter 12 3. New project analysis You must evaluate a proposed spectrometer for
ID: 2643526 • Letter: C
Question
chapter 12
3. New project analysis
You must evaluate a proposed spectrometer for the R&D department. The base price is $300,000, and it would cost another $75,000 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 $105,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $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 $62,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.
a. 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.
$
b. 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 $
Explanation / Answer
Cash outflow in year 0 = base price+cost of modification = 300,000+75,000 = $375,000
Assumption: the 6,000 increase in net working capital will happen every year.
Year 1 calculations:
Depreciation = 33% of 375,000 = 123,750. Value of spectrometer after depreciation = 375,000 - 123,750 = $251,250
additional working capital requirement = 6,000. savings in labour costs = 62,000
Net cash flow = inflows-outflows = 62,000 - 6,000 - 123,750 = -67,750 (this is the pre-tax amount of net cash outflow for year 1)
Year 2 calculations:
depreciation = 45% of 251,250 = $113,063 balance value of the asset = 251,250 - 113,063 = 138,188
Additional working capital = 6,000. savings in labour cost = 62,000
cash flow for year 2 = 62,000 - 6,000 - 113,063 = -57,063 (this is the pre-tax amount of net cash outflow for year 2)
Year 3 calculations:
depreciation = 0.15*138,188 = 20,728
post tax savings in labour cost = (1-0.4)*62,000 = 37,200
So cash flow for 3rd year = 37,200 - 20,728 - 6,000 = $10,472 (cash inflow)
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