The president of the company you work for has asked you to evaluate the proposed

Question

The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department The equipment's basic price is $70,000, and it would cost another $15,000 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $30,000. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,000. The machine would have no effect on revenues, but it is expected to save the firm $25,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40%.

What is the Year-0 net cash flow?

What are the net operating cash flows in Years 1, 2, and 3?

What is the additional (nonoperating) cash flow in Year 3?

If the project’s cost of capital is 10%, should the chromatograph be purchased?

Explanation / Answer

Statement of net Cash flow year wise

Thus, Based on above analysis,

(i) Year -0 Net Cash Flow is $ 45,132

(ii) Net opearting Cash Flow in

Year-1 $ 11,000

Year-2 $ 11,000

Year-3 $ 15,000

(iii) Additional (non opearating) cash flow in year 3 is $ 18,000

Particulars Year-0 Year-1 Year-2 Year-3 NET 1 Basic Price 70,000 -   -   -   2 Additional Price 15,000 -   -   -   3 Sales value of Equipment After Tax -   -   -   18,000 4 Working Capital cost 4,000 4,000 4,000 -   5 Saving in Cost per annum before tax -   25,000 25,000 25,000 6 Tax -   10,000 10,000 10,000 7 Saving in Cost after tax -   15,000 15,000 15,000 8 net cash flow 89,000 -11,000 -11,000 -33,000 9 Discount factor 1.000 0.909 0.826 0.751 10 Present Value 89,000 -9,999 -9,086 -24,783 45,132

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