You must evaluate a proposed spectrometer for the R&D department. The base price

Question

You must evaluate a proposed spectrometer for the R&D department. The base price is $270,000, and it would cost another $40,500 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 $108,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $7,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $69,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

Explanation / Answer

1. Initial Investment = $270,000 + $40,500 = $310,500

2. This is best answered with a table, but I'm not sure how to do that because it gets rid of the spaces, so they are listed in order below:

Year 1 Year 2 Year 3

Amount Saved 69,000 69,000 69,000

Depreciation -89,100 -121,500 -40,500

Net Income -20,100 -52,500 28,500

Taxes @ 40% +8040 +21,000 -11,400

Net Income -12,060 -31500 17,100

Depreciation Adj. +89,100 +121,500 +40,500

Change in NWC -7,000 -- +7,000

Sale of Machinery -- -- +108,000

Cash Flows $70,040 $90,000 $172,600

3. npv(11,-310500,{70040,90000,172600}) = -$48151.25 --> do not purchase because the NPV is negative.

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