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 $110,000, and it would cost another $27,500 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 $27,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $10,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $41,000 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.

Year 1: $_____

Year 2: $_____

Year 3: $_____

Explanation / Answer

Assuming NWC (spares ) inventroy in returned after 3 year period. Asset Cost(Base value+modification)=              137,500 Book value remaining after 3 years @7%=                  9,625 Resale value after 3 years                27,500 Capital Gain                  17,875 Tax on Capital Gain @40%                  7,150 MACRS rate   Year 1 Year 2 Year 3 33.00% 45.00% 15.00% Projected Cash Flows Details Year 0 Year 1 Year 2 Year 3 Investment in Equipment           (137,500) Net Working Capital              (10,000)                  10,000 Salvage Value                    27,500 Pre Tax Labor cost saving                   41,000              41,000                  41,000 Depreciation                (45,375)            (61,875)                (20,625) Taxable Income                 (4,375)            (20,875)                  20,375 Tax @40%                   1,750                8,350                  (8,150) Tax on Capital Gain @40%                  (7,150) Post Tax Income                 (2,625)            (12,525)                    5,075 Add Back depreciation=                 45,375              61,875                  20,625 Net Cash flow(with salvage & NWC)           (147,500)                 42,750              49,350                  63,200 Year 0 Year 1 Year 2 Year 3 So Projected Annual Cash Flows Yearwise             (147,500)                 42,750              49,350                  63,200

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