You must evaluate the purchase of a proposed spectrometer for the R&D department
ID: 2657299 • Letter: Y
Question
You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $90,000, and it would cost another $13,500 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 $36,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $5,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $47,000 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? Round your answers to the nearest cent.
In Year 1 $
In Year 2 $
In Year 3 $
If the WACC is 14%, should the spectrometer be purchased?
Explanation / Answer
Cost of Equipment = Base Price + Additional Modification Cost
Cost of Equipment = $90,000 + $13,500
Cost of Equipment = $103,500
Depreciation for Year 1 = 33% * $103,500
Depreciation for Year 1 = $34,155
Depreciation for Year 2 = 45% * $103,500
Depreciation for Year 2 = $46,575
Depreciation for Year 3 = 15% * $103,500
Depreciation for Year 3 = $15,525
Book Value at the end of year 3 = 7% * $103,500
Book Value at the end of year 3 = $7,245
Salvage Value = $36,000
After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax
After-tax Salvage Value = $36,000 - ($36,000 - $7,245) * 0.40
After-tax Salvage Value = $24,498
Initial NWC required = $5,000
Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF for Year 1 = $47,000 * (1 - 0.40) + 0.40 * $34,155
OCF for Year 1 = $41,862
OCF for Year 2 = $47,000 * (1 - 0.40) + 0.40 * $46,575
OCF for Year 2 = $46,830
OCF for Year 3 = $47,000 * (1 - 0.40) + 0.40 * $15,525
OCF for Year 3 = $34,410
Answer a.
Initial Outlay = Cost of Equipment +Initial NWC required
Initial Outlay = -$103,500 - $5,000
Initial Outlay = -$108,500
Answer b.
Net Cash Flow in Year 1 = OCF for Year 1
Net Cash Flow in Year 1 = $41,862
Net Cash Flow in Year 2 = OCF for Year 2
Net Cash Flow in Year 2 = $46,830
Net Cash Flow in Year 3 = OCF for Year 3 + After-tax Salvage Value + NWC recovered
Net Cash Flow in Year 3 = $34,410 + $24,498 + $5,000
Net Cash Flow in Year 3 = $63,908
Answer c.
NPV = -$108,500 + $41,862/1.14 + $46,830/1.14^2 + $63,908/1.14^3
NPV = $7,391.30
Yes, the spectrometer should be purchased.
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