You must evaluate the purchase of a proposed spectrometer for the R&D department

Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $240,000, and it would cost another $36,000 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 $108,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $66,000 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. Negative amount should be indicated by a minus sign.
$

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 $

c-If the WACC is 13%, should the spectrometer be purchased?

Explanation / Answer

A- Initial investment outlay = base price+ modification cost + investment in working capital= 240000+36000+8000= $284000

B- Calculation of Annual Cashflows

Working Note:

1) After Tax salvage value= Sale price- (tax on profit on sale of equipment)= $108000 - ( $88680 * 0.40 )= $72528

profit on sale of equipment= sale - bookvalue= 276000- (276000-91080-124200-41400) = $88680

2) Depreciation is calculated on capitalised cost i.e. $240000 + $36000 = $276000

C) Calculation of NPV of investment

Therefore NPV = Total Present Value of annual cash inflows - Initial Outlay = $199282- $284000= -$84718

Since NPV is negative so  spectrometer should not be purchased.

PARTICULARS YEAR 1 YEAR 2 YEAR 3 Saving in Labor costs 66000 66000 66000 Less: Depreciation 91080 124200 41400 Profit before tax -25080 -58200 24600 Less: tax@40% 0 0 9840 Net Income -25080 -58200 14760 Add: Depreciation 91080 124200 41400 Add: After tax salvage value(WN) 0 0 72528 Annual Cash flow 66000 66000 128688

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