New project analysis You must evaluate a proposed spectrometer for the R&D depar
ID: 2724300 • Letter: N
Question
New project analysis You must evaluate a proposed spectrometer for the R&D department. The base price is $160,000, and it would cost another $32,000 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 $72,000. 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 $54,000 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. $
What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent. in
Year 1 $
Year 2 $
Year 3 $
Explanation / Answer
Calculation of Year 0 project cash flow:
Base Price of Project
$ 160,000
Add: Modification costs
$ 32,000
Cost of Project
$ 192,000
Add: increase in net operating working capital
$ 10,000
Year 0 project cash flow (Outflow):
$ 202,000
Calculation of project's annual cash flows in Years 1, 2, and 3:
Year 1
Year 2
Year 3
Tax Saving on Depreciation
$ 25,344.00
$ 34,560.00
$ 11,520.00
(Cost * Depreciation rate * tax rate)
(192000*33%*40%)
(192000*45%*40%)
(192000*15%*40%)
Sale value at the end of year 3
$ 72,000.00
Tax saving on Capital loss on sale at the end of year 3:
Book Value at the end of year 3 = (192000-25344-34560-11520) = $120576
Loss on sale = 120576 - 72000 = 48576
Tax Saving on loss on sale = 48576 *40% =
$ 19,430.40
Saving in After-tax labor costs = 54000 * (1-40%) =
$ 32,400.00
$ 32,400.00
$ 32,400.00
Net Cash Flows
$ 57,744.00
$ 66,960.00
$ 135,350.40
Calculation of Year 0 project cash flow:
Base Price of Project
$ 160,000
Add: Modification costs
$ 32,000
Cost of Project
$ 192,000
Add: increase in net operating working capital
$ 10,000
Year 0 project cash flow (Outflow):
$ 202,000
Calculation of project's annual cash flows in Years 1, 2, and 3:
Year 1
Year 2
Year 3
Tax Saving on Depreciation
$ 25,344.00
$ 34,560.00
$ 11,520.00
(Cost * Depreciation rate * tax rate)
(192000*33%*40%)
(192000*45%*40%)
(192000*15%*40%)
Sale value at the end of year 3
$ 72,000.00
Tax saving on Capital loss on sale at the end of year 3:
Book Value at the end of year 3 = (192000-25344-34560-11520) = $120576
Loss on sale = 120576 - 72000 = 48576
Tax Saving on loss on sale = 48576 *40% =
$ 19,430.40
Saving in After-tax labor costs = 54000 * (1-40%) =
$ 32,400.00
$ 32,400.00
$ 32,400.00
Net Cash Flows
$ 57,744.00
$ 66,960.00
$ 135,350.40
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